Books get smaller

IE‘s 2008 survey was taken after the financial crisis had begun but before things got really ugly. Brokers were still growing their books. This year, all that has changed: assets under management are down and the number of client households are creeping upward. It appears advisors are cushioning the effect of declining portfolio values by adding clients.

The starkest evidence of the downturn’s impact is the drop in the average advisor’s AUM. Overall, AUM slipped to $70 million this year from $86.3 million a year earlier. Although this 19% drop is notably less than the 30%-40% decline that many equities markets have endured over the past year, it is nevertheless a significant reduction.

At the same time, the number of households the average advi-sor is serving has crept up, to 218 this year from 212 last year. As a result, advisor productivity — as defined by AUM/household — has dropped, slipping to less than $440,000 this year from more than $560,000 in 2008. The same basic shifts are evident when the respondents are divided into top-producing brokers and the rest of the industry.

IE divides its survey population into top performers and the rest of the industry in line with the 80/20 rule — defining the top producers as the top 20% of advisors based on AUM/household. On that basis, the industry’s top producers have much different books than the rest of the industry.

The average broker in the top 20% is sitting on average AUM/household of $1.2 million, vs $256,708 for the rest of the industry. For both groups, this is down significantly from last year, when the top 20% reported average AUM/household of more than $1.5 million and the other 80% averaged $325,301.

Despite these significant declines in broker assets and productivity, the distribution of client accounts remains remarkably stable. The only notable shift in overall account distribution from 2008 to 2009 is a drop in the proportion of accounts worth less than $100,000, which declined to 10.6% this year from 11.7% last year. Both top producers and the other 80% are managing to shed these small accounts, which firms and advisors generally consider the least desirable.

The average top producer made the biggest gain in accounts in the $250,000 to $1-million range, with their share of the total book climbing to 43.6% this year from 40.6% the prior year. Accounts worth more than $1 million remain the biggest portion of the top broker’s business, at 47% of his or her book — although this is down slightly from 2008, when this client segment comprised almost half of top brokers’ books.

The other 80% managed to maintain its share — 19% on average — of these coveted $1 million-plus accounts. For these advisors, accounts in the $250,000 to $1-million range remain the biggest portion of their books, at about 50%. But accounts in the $100,000 to $250,000 range provided the biggest gain year-over-year, comprising 18.4% of their books this year vs 17.4% last year.

The fact that the market downturn does not appear to have affected the account distribution of the brokers in IE‘s survey is somewhat surprising. With most clients’ equities portfolios probably taking large hits and advisors’ overall AUM declining substantially, it is reasonable to assume that bro-kers’ account distributions would drift toward the lower ranges — undoing much of the work that many brokers have done in recent years to shift their businesses toward higher net-worth clients.

Yet that doesn’t seem to be the case. Instead, it appears that relatively few clients have slid into lower account-size categories. And the work of previous years seems to have paid off in terms of preserving this higher-value account mix and maintaining overall client numbers.

The market turmoil has, however, had some obvious effects on other parts of brokers’ businesses. For example, there are notable shifts in sources of revenue.

For several years now, transactions have been declining in significance as advisors’ source of revenue; indeed, fee-based revenue streams have taken over as the leading generator of revenue for the average broker in the top 20%.

@page_break@Although this overall picture hasn’t changed, the long-running decline in the popularity of transactions did stall somewhat this year, as respondents to our survey reported that transactions are responsible, on average, for 47% of their revenue this year, up from 45% last year. Fee-based sources remained flat at 44% of revenue.

Transactions increased in importance for both the top 20% of brokers and the rest of the industry, although the shift was more pronounced for the top producers. The average top producer saw his or her reliance on transactions rise to 40.5% this year from 38.5% of revenue in 2008. Similarly, dependence on fees slipped to less than 49% this season from 50% last year.

The other notable decline for top producers came in deal-based revenue, which fell to less than 5% this year from 7% of revenue last year. As financial markets have faltered, deal inflow has dried up; the effects of this are filtering down to retail brokers and their clients.

Conversely, the average share of revenue that comes from branch manager overrides rose to 2% this year from just 1.1% in 2008. This trend was also far more pronounced among the top producers, who saw their reliance on this revenue stream jump to 2.6% this year from less than 1% last year.

Average insurance revenue also tumbled — to $61,813 from $72,421. (See also page C8.) This is, however, one area in which there is a sharp distinction between the top producers and the other 80%. The average top producer actually saw his or her revenue from this source rise — to $82,415 this year from slightly less than $75,000 last year. The decline came in the rest of the industry. Although average insurance revenue for the other 80% was almost on par with the top producers last year, at slightly less $72,000, this year that slipped to $57,361.

It appears that the top producers are doing a better job of seizing the opportunities presented by the financial crisis. One opportunity is clients’ increasing demand for products that provide guarantees or stable income streams. These changing appetites are reflected in the rising popularity of segregated funds and annuities within brokers’ insurance product mix.

Last year, seg funds represented 22% of the average broker’s insurance business; this year, seg funds’ share is up to 33.3%. Similarly, annuities have climbed to a 6% share of the average broker’s insurance business, up from a 4% share a year ago. This shift is largely at the expense of traditional life insurance products, both term and permanent, which are seeing notable declines in their share as a result.

While both top producers and the other 80% are reporting big jumps in their use of seg funds, it’s the top 20% of brokers who are driving the increasing use of annuities. Last year, less than 4% of their insurance business was in annuities; this year, that’s up to 10.4%.

The asset mix has also evolved significantly among brokers’ traditional investment products, probably driven by rising risk aversion in the face of the tumultuous financial markets. In short, allocations to equities, mutual funds and alterative investments are down on average from last year. The use of proprietary managed products and income trusts is more or less flat from last year. Meanwhile, less risky, more cost-effective and less conflicted products — bonds, exchange-traded funds and third-party managed products, respectively — all saw their allocations increase year-over-year.

Equities remain the biggest portion of the average broker’s book at 34%, but this is down from 39.5% last year. Similarly, mutual funds are hanging onto second place with a share of slightly less than 22%, down from 23.3% share last year. And bonds solidified their hold on third place with a 19.2% share of the average book, up from 18.4% last year.

The bigger shifts are taking place outside these core portfolio holdings, in offerings such as third-party managed products, which saw their share of the average book jump to 6.4% this year from 5.1% last year; and ETFs, which climbed to 3.6% this year from 2.9% last year.

Worth noting, it is the top producers who are driving the increased use of the cost-effective ETF option; the allocation to this asset class more than doubled to 5.5% of their books in the current survey from 2.3% in last year’s survey.

Top advisors’ use of managed products — both proprietary and third-party — also increased over the past year to a combined 10.6% of the average book, almost on par with mutual funds’ 11.6% share. Last year, managed products had a combined 9% share of the average top producer’s book, vs 13.2% for mutual funds.

Mutual funds remain more popular with the other 80% of the advisors. They maintained a 24.6% share of the average book in 2009, still far ahead of the 10.9% that’s in managed accounts.

In particular, both sides of the industry increased their exposure to third-party managed products, with the top 20% allocating 6.9% of AUM to this product type in 2009, vs a 5.6% allocation in 2008. The rest of the industry boosted its exposure to third-party managed products 6.5% this year from slightly less than 5% last year.

The Canadian brokerage industry could hardly expect to remain immune as the deepening financial crisis spilled over into the overall economy. Now, the repercussions are evident on asset levels, revenue sources and product mix. Yet, the industry remains far from being in crisis itself. It appears to be adapting to the new normal. IE