Low-Cost Brokers Gain Clients After 2008 Financial Crisis
A tsunami hit the brokerage industry in 2008. The stock market experienced its historic nose-dive. So did individual investors' trust, especially in big financial firms.
Wire houses -- Wall Street's iconic full-service brokerages -- saw their share of individual investors' assets slip to 20% in 2009 from 21% the year before.
Smaller financial shops saw their slices of the pie grow larger. Registered investment advisers -- many of whom quit wire houses -- ended up with 3% of retail investors' assets, up from 2%.
And discount brokerages, including those run by mutual funds, ended up with 14%, up from 13%.
"A lot of investors felt they weren't getting their money's worth from the wire houses, so they left," said Ken Leon, equity research analyst for S&P Capital IQ.
The Heat Was On
A lot of brokers and advisers jumped ship too, taking clients with them.
"They felt they could serve their clients' needs better on their own or in smaller advisory firms, where they could have more say in rules -- make sure the rules would work for their clients," Leon said.
Many investors felt that their scorching came from riding down on the wire houses' pet products.
A vicious cycle set in.
As the market fell, investors grew more reluctant to bet good money after bad. That rocked the market more.
With fees from assets under management falling, big brokerages laid off brokers and advisers.
Many clients followed them to new positions at smaller firms, further depleting wire houses' market share.
Many clients switched to online brokerages, a few of which --Schwab ( SCHW ), for one (and a favorite in the Best Online Brokers survey) -- offer advice from consultants. Many online brokerage clients are happy to make their own investment decisions.
"I don't think professionals manage my money any better than I can," said Joe Greene, a 42-year-old certified fire-alarm technician for the Osceola Count school district in Florida, who invests through Scottrade and has profited on all four covered call trades he's made this year.
Many individual investors have yet to regain their nerve from the '08 crash.
"A lot of people feel it's too difficult to make investment decisions," said Morningstar analyst Gaston Ceron. "So they're putting their money into ETFs or broad market index mutual funds or bonds -- anything but stocks."
Industrywide, assets under management plunged 30% to 40% from the October 2007 market peak to the March 2009 bottom, says Scott Smith, director of financial industry research firm Cerulli Associates. Management fees fell by the same proportion.
Full-service brokerages felt most of the pain, Smith says.
As the financial crisis peaked, 94-year-old Merrill Lynch found itself drowning in a sea of mortgage-related securities it owned. The company was hemorrhaging billions of dollars due to defaults on subprime loans.
And its collateralized debt obligations (CDO) were collapsing in value.
It agreed to a buyout in September 2008 byBank of America ( BAC ) amid investor fears that the brokerage was about to fail as Lehman Bros. had only days before.
CDOs also forced the sale of Smith Barney. In January 2009,Citigroup ( C ) was stuck with shrunken-value CDOs, which it had underwritten but could not sell.
Desperate for cash as it was bailed out by the government, Citi sold Smith Barney toMorgan Stanley ( MS ).
A similar fate awaited Wachovia, which got sold toWells Fargo ( WFC ).
And Swiss banking giantUBS (UBS) -- whose army of wealth management advisers compete with Merrill and Morgan Stanley -- was besieged by the IRS and several U.S. states for allegations ranging from tax evasion to misrepresenting the value of auction-rate securities.
The low interest-rate environment since the meltdown has dampened earnings from banking operations at online brokerages such as Schwab andTD Ameritrade (AMTD), Ceron says.
Like their own depositors, it's hard for banks to find low-risk yield, Ceron adds.
The fallout has not stopped.
Among investors who played musical chairs with brokerages in 2012, 52% of self-directed investors dumped a full-service broker, according to a Cerulli Associates study. And 19% of self-directed investors switched from another online brokerage.
Online brokerages have big differences. Schwab, with its network of independent advisers, can offer contact with advisers as well as low-cost online trading.
Joining The Trend
Then there are the full-service brokerages. Just as one-time discount brokerages have expanded their offerings, wire houses such as Morgan Stanley Smith Barney andJPMorgan Chase (JPM) are fighting back and rolling out cut-price, do-it-yourself investing channels .
Cerulli's Smith cites $7 trades offered by Merrill Lynch via Merrill Edge.
"They have access to 30 million Bank of America customers who aren't wealthy enough for a traditional, full-service brokerage, but who can be well serviced other ways," he said.
Steps such as those may be why the shift in market share from full-service brokerages to online brokerages is slowing, says Leon. "Traditional brokerages excel at servicing the mass affluent market up to the high new worth and ultrahigh net worth," he said. "Online brokerages are not designed to do that."
Neither type of brokerage is likely to disappear.
"Customer segmentation is more distinct than it was five years ago," Leon said. "There are opportunities for both ends."