Schwab’s Pure Independent Play Leads to US Family Office Goldmine

Matthew Smith, New York, August 6, 2008


As bad mortgage bets continue to untangle some of Wall Street’s most complex money making machines, the business of purely independent wealth management in the US is thriving, and no firm is better positioned to capture these assets than Schwab Institutional.

As bad mortgage bets continue to untangle some of Wall Street’s most complex money making machines, the business of purely independent wealth management in the US is thriving, and no firm is better positioned to capture these assets than Schwab Institutional.

People may know Charles Schwab Corporation as the most American of all American discount brokerage brands that made a name for itself by capitalising on the emergence of do-it-yourself trading; indeed Schwab currently has 7.2 million client brokerage accounts and is still run by its namesake, Charles ‘Chuck’ Schwab.

Schwab Institutional is one of the firm’s three business units (Schwab Investor Services is the brokerage portal for individuals; Schwab Corporate & Retirement Services is the other business unit that administers retirement plans for business clients). SI was created when Schwab went public in 1987 and is now emerging as the fastest growing part of the Schwab franchise, feeding off the valuable and highly prized ultra rich client assets.

Schwab Institutional essentially is a provider of custodial, operational and trading services to independent investment advisors.

While Schwab Institutional may not speak directly to high net worth clients, it is certainly presiding over a healthy proportion of this industry segment’s asset. Currently, Schwab Institutional has $575.3 billion in assets, administered on behalf of some 5,500 Registered Investment Advisory firms (RIAs are fee only advisory practices in the US that are independent from the influence of investment product providers).

Independent advice continues to be sought by the ultra wealthy – Cerulli Associates data suggests the amount of client assets within RIAs businesses have doubled to over $2 trillion during the last five-years and there has been up to 20 per cent growth in advisor numbers year-on-year into this segment.

And Schwab’s own asset growth reflects the growth of the independent market – Schawb Institutional brought in around $9.2 billion in assets in the first six months of this year, the same amount it brought in during the entire calendar year in 2007; the business expects 15 per cent more RIAs will partner with Schwab this year compared to 2007.

“We like the position of our firm at the moment, especially if you look at the market now,” says Bernard Clark, SI’s senior vice president of sales and relationship management.

“Our whole model ties together in with the fact advisors like to say they are fully independent, and they are able to limit any conflicts or perception of conflicts their clients may have with them by using us; we’re not owning them, so there is no conflict, we’re open architecture; they’re not on a commission basis.”

The number of advisory practices that are plugging into Schwab Institutional might not seem like a lot – in 2007, 114 new advice practices started using the custodian and service provider. But the value of the model is that it suits advisory firms with high clients balances – particularly single and multi-family offices.

Mr Clark points out that family offices represent SI’s fastest growing business segment in terms of new assets.

“This model suits the family office structure that wants to remain independent but they are not managing the assets in house,” says Robert Testa, a researcher with Cerulli Associates.

Mr Testa estimates there to be somewhere between 3,500 and 4,000 single and multi-family offices within the RIA segment that comprises approximately 17,000 practices.

He says on average single family offices in the US have client assets upwards of $400 million, and MFOs tend to be in the average range of $4 billion.

“These businesses are full service and usually have the best of breed technology and people so they are expensive to run so they really need at the very least $200-400 million under advice to work,” says Mr Testa.

Cerulli is reticent to approximate the size of the family office segment in the US at the moment; Schwab estimates the market currently to represent between $700 billion and $1 trillion.

“If an ultra high net worth client is looking for truly independent advice, that’s when you’ll see them moving towards the family office, particularly in this environment,” says Mr Testa.

Schwab is by no means the only custodian partnering with RIAs and providing additional client management and portfolio accounting tools in the United States – but it is currently the biggest.

According to Schwab’s own industry figures, SI currently has around 25 per cent of the market. Its next closet competitor is Fidelity, with around 11.5 per cent; then Pershing and TD Waterhouse control around 3-4 per cent of the fee-only third party custodian and servicing business.

Mr Clark estimates the total fee-based advisory industry to be around $2.4 trillion and growing.

“The opportunity for us is expanding as traditional brokers and advisors leave the commission model,” he says.

“We’re finding a lot of brokers from all of the wire houses. They are saying ‘hey, I’d like to run my business, I’d like to be an entrepreneur, I’d like to create an investment philosophy that is independent for my clients, with independent products and open architecture’.”

In an effort to continue to attract client assets away from traditional Wall Street brokerage businesses, SI this year started lending advisors capital to set up their own practices.

The programme was in a pilot phase for the first six months of the year and has recently “gone live” to the broader market.

According to Schwab, the firm doled out $1.5 million in loans to advisors starting up their own practices as part of the Schwab Business Start-up Solutions packages pilot programme.

Mr Clark is quick to distance this offering from payment schemes that exist in the industry designed to lock in advisors.

“It is just that – it is a getting started programme, it is start up funding – this is not a wire house locking in people programme,” he says.

The purely open architecture and independent nature of the Schwab Institutional model means has its flaws, though, because there is nothing stopping advisors from taking their client’s money and placing it elsewhere.

“Our belief is if we do well by them, they do well by us. We’re not into the idea of holding advisors, we think the concept of them being fully independent and us being a provider of services is key to our model – they can leave us, but we have a high retention rate and we continue to grow our asset base.”

However he says there is no other way for institutions to get access to these highly desired assets.

Mr Clark considers the “independent contractor” model, a prevalent model in the advice industry in which the broader group shares the revenue stream of the individual advice firms, to not be a “fully independent” structure.

“Independent contractors are a brokerage firm by another name – they are using proprietary product to bring more revenue streams to their firm,” he says.

Fee only advisors, he says, tend to have better businesses and less turnover in volatile markets.

“Clients of advisors, especially independent advisors, are still reasonably calm in this market… by and large advisors have deep relationships and the clients have more commitment to their overall investment strategy and philosophy,” Mr Clark says.

Schwab makes its money on spreads on cash balances that advisors have with the institution as well as per transaction on product and brokerage performed through the system.

Mr Clark admits overseas markets present an opportunity for Schwab Institutional to expand, but he says there are currently no plans on the cards to apply the model to Europe where regulatory differences present a barrier.

“Our focus right now is expanding into different segments in the US, in particular into trusts and family offices.”

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