Full-service fears subside with the market

In light of the recent market weakness, particularly the meltdown in the value of Nasdaq-listed issues, the threat of self-service brokerages are fading fast.

“There is not much competition this year. It has definitely gone down and we don’t hear about it,” says one broker from Edward Jones. “There has been a huge change in the past seven or eight months.”

The diminishing threat was a common theme among many brokers. “You know, we saw that about a year-and-a-half ago, but I just don’t think it is a problem in the same way any more,” says a Canaccord Capital Corp. broker.

It’s no wonder. The Nasdaq sell-off has wiped out the appeal of investing in “dot-coms” for investors and many of discounters report drastic drops in business.

“E*Trade [Canada Inc.] will take some business, but it’s not as much of a threat as we first thought,” says another Canaccord broker.

In fact, this year’s survey shows many of the brokers are regaining some of the business that had migrated to self-service.

“We’ve had a lot of people who have been trading electronically calling us and asking for a second opinion on trades. I think, in general, people are seeing the benefits of having full service,” says the same broker.

“[Discounters] were a threat when they first came out. People wanted to try them out and see how they worked, but most people have come back to using full service. Most people just don’t have the time to do the research required,” says another.

So will the late 1990s be remembered as an anomaly, a time when the boat rocked but soon righted itself, with 2001 the year everything returned to “normal”? Perhaps, but be careful. A common metaphor attached to technology is that of Pandora’s box: once technology is unleashed on the world, it can never be put back.

That’s probably true with the discounters. While their influence may be waning, some of the mindsets and the technologies they spawned have changed the industry forever.

“We’ve probably left behind the notion of a purely discount brokerage or a full-service brokerage,” says Paul Bates, CEO of Charles Schwab Canada Co. in Toronto. “The reason is — it’s what I call one of those blinding glimpses of the obvious — is that almost all investors spend some of their time as a self- managed investor and some of their time as an investor who needs advice and guidance.”

The investing universe, he says, can be broken into three categories: “self-directed” at one end and “delegators” at the other, with the middle made up of investors known as “validators,” who make use of both services.

“They are probably the biggest segment of the market,” says Bates, who says validators are a bigger proportion of the Canadian market than the U.S. market, in which there seems to be a polarization toward either end of the spectrum.

He says 60% of Schwab client assets are in self-managed accounts and roughly 40% in advisory accounts. But about a quarter of their clients actually have both an advisory and a self-managed relationship. ” I think that’s going to continue to increase,” says Bates.

So what does this have to do with the waning oomph of discounters?

Hybrid accounts, in which self-service accounts and full-service accounts are bundled together, are beginning to slip onto the radar screen. BMO Nesbitt Burns Inc. and ScotiaMcLeod Inc. have both recently launched such programs by adding a discount component to their full service-offerings, while Schwab has approached the concept from the other direction, by adding IAs to its discount service.

From this perspective, discounters are a necessary step in the evolution of full-service firms.

“On reflection, I don’t think that the discount model was wrong. A lot of the technological innovation that has occurred in the brokerage industry in the past decade or so has come from the discount brokerage community,” says Bates.

“There’s a logical rational for why we’ve seen the history we’ve seen,” he says. “The interesting opportunity and challenge now is how we use the technologies we’ve developed, to change the nature of the advisory relationship.”

That the discount brokerage industry is evolving away from its initial business model has sent discount firms scrambling to revamp their offerings.

TD Bank Financial Group is currently looking at how to knit its discount brokerage, TD Waterhouse Investor Services Inc., together with TD Evergreen Investment Services Inc., its full-service arm.

ENorthern, the discount brokerage arm of Northern Securities Inc. (ranked closely behind E*Trade in Gomez Inc.’s ranking of discount brokers), is expanding to include IPOs and private placements on its Web site. E*Trade, perhaps the most recognized name in the discount space, is busy turning itself into a regular bank. It’s impossible to walk through Manhattan now and not run into an E*Trade ATM, as they’re in just about every corner store.

“I don’t think anyone has found the gene yet, to how we unlock or bring the advisory business into the Web age. I think we’re hunting in the right place. But I don’t think anyone has figured to how to do it in an earth-shattering way. They’re trying to figure it out,” says Bates.

Nevertheless, the hybrid programs definitely seem to be getting something right. Scott Hudson is the product manager for Scotia’s hybrid program, i:PARTNER, which was launched by the bank in November and offers clients access to a full-service advisor as well as Scotia’s discount brokerage services. “It’s been our most successful product launch ever. In terms of the IAs who have embraced it, the feedback has been really positive.”

Until now, clients were forced to choose either a self-directed or a full-service account. Although the program isn’t very old, Hudson says, it has already attracted some 675 accounts and $85 million in assets.

“It’s a new concept in Canada. A lot of people don’t know fee-based exists, let alone a hybrid account,” he says. In the U.S., which is often a couple of years ahead, Merrill Lynch & Co. has been actively promoting its Unlimited Advantage program, a hybrid account.

Not only do the IAs like it, says Hudson, but clients appreciate the convenience, since they can draw from their brokerage account, which appears on the same Web page as their bank account. “I think it’s the future,” he says.