Monday, July 10, 2006

Discount Brokerages’ Threat Increases

Investment Executive, Rudy Mezzetta, 10 July 2006

Online discount brokerages, which allow investors to manage their own portfolios and, increasingly, obtain advice, is accounting for a growing share of total retail assets. Industry leaders and experts say the trend is putting extra pressure on full-service advisors to adapt to investors’ changing expectations.

The online or discount business grew to $155 billion in assets by March 2006, up 26% from the year before, and represents 19.4% of total retail brokerage assets, up from 18.4%, says Investor Economics Inc. of Toronto.

“It’s here to stay,” says Jamie Sutherland, senior analyst at the Toronto-based research firm. “There’s no doubt the online discount brokerage business is growing. This whole sector will grow dramatically.”

The traditional industry segment is acutely aware of its powerful rival.

“If the full-service channel doesn’t respond, [online brokerages] could pose a serious threat,” says Simon Edwards, chief executive at Toronto-based HSBC Securities (Canada) Inc. “But my feeling is the full-service channel is responding.”

Edwards, who heads HSBC InvestDirect online brokerage as well as the firm’s full-service wealth-management channel, says full-service has to make sure it provides value superior to self-directed service, with a focus on comprehensive advice and relationship management. “It has to be a high-end, high-touch proposition,” he says.

The self-directed business is dominated by the online brokerage arms of the big banks, which claim around 90% of total Canadian market assets, according to industry insiders. The online channel saw its heyday in the high-tech boom of the late 1990s, but was hit hard when the bubble burst. In the past five years, the online business has rebuilt itself, but insiders say the clients have changed.

“There has been an evolution from traders to investors,” says Connie Stefankiewicz, president and CEO of BMO InvestorLine.

“Five years ago, it was all about price and execution,” says Duncan Hannay, head of Toronto-based E*Trade Canada. “While price is still a drawing card, product and quality of service are just as important.”

Most clients, insiders say, are “everyday” investors who enjoy running their own investment portfolios and are attracted to the low costs. About 1% could be classified as active traders, those who trade more than 30 times in a quarter, and such clients are highly coveted because their frequent trading adds to commission revenue.

Although some clients use their online accounts as their primary or only investment portfolio, others use one as a companion or a sideline to an advisory account. “You’ll often see a client holding a registered account with an advisor, and his or her non-registered account with an online broker,” Stefankiewicz says. HSBC’s Edwards says most of his firm’s online clients use their accounts as a primary investment account.

More than ever, clients are being offered opportunities to receive advice online, to help them make sense of the myriad of products and choose among a variety of investment strategies.

“Access to advice will be critical in the next few years,” says Marvin Daley, a regional head of TD Waterhouse financial planning and discount brokerage.

The biggest player in the group, TD Waterhouse offers discount brokerage services online, by phone or at 24 investor centres across Canada. It also offers discount investors with more $100,000 in assets access to a fully licensed financial planner at no cost.

Most other online brokerages are also searching for ways to give clients a higher level of support and advice. BMO InvestorLine offers clients model portfolios for mutual funds, exchange-traded funds and, coming in weeks, equity products managed by third-party providers.

Online brokerages are also looking for ways to make it easier for clients to use their Web sites, and to provide them with ways to clear a path through a thicket of investment choices. For example, Stefankiewicz says BMO InvestorLine has asset-allocation tools, retirement tools and other features to guide clients through investment decisions, provide relevant suggestions and give them validation for their choices.

“We can help investors by packaging information, in a way that’s relevant to them,” she says.

Despite the growth of the discount brokerage sector, most experts say the full-service business can continue to thrive, especially if it focuses on its strengths.

“I think the advisory community can take advantage of this phenomenon,” says Paul Bates, dean of the DeGroote School of Business at McMaster University in Hamilton, Ont. “It can more finely target that which adds the greatest value. Advisors know their clients best.” Bates was president of four brokerage and investment firms, including Charles Schwab Canada before its acquisition by Bank of Nova Scotia in 2002.

Daley says high net-worth clients will always need the advice, products and services a full-service advisor can provide. “Once you reach a larger asset size, it’s important to look for expert advice,” he says.

There is also a question of the survival of the online brokerages. The dozen or so players are currently fighting it out over pricing, with E*Trade Canada firing the latest salvo by setting a low flat fee for active investors, with other brokerage houses adjusting their fee structures in response. They are also competing on features, technology, access to foreign markets and security guarantees for clients.

Most industry experts agree the barriers are too high for a new player to enter the Canadian online brokerage market. But some say there could be consolidation in coming years.

“I foresee some consolidation,” says HSBC’s Edwards, adding that smaller firms without diverse revenue streams may feel the pinch and end up as acquisition targets.

Insiders say the online brokerage business and its clients are mature enough to survive an extended market downturn, and won’t repeat the run for the doors witnessed with the high-tech bust.