Wealth management industry wary over year ahead

Fri Jan 11, 2013 4:14pm EST

* Retail investors still nursing 2008 wounds

* Recruiting expenses, compliance costs keep rising

* Asset gathering, increasing fees are partial antidotes

By Jed Horowitz and Suzanne Barlyn and Ashley Lau

NEW YORK, Jan 11 (Reuters) - After four of the most difficult years many can remember, brokerage executives and advisers are on edge about their ability to generate profits in 2013.

Equity markets have been on a tear the last two years, but individual investors side-lined by the 2008 financial crisis remain wary and are keeping funds in conservative fixed-income investments despite the advice of financial advisers.

At the same time, executives at Merrill Lynch, Morgan Stanley and other major firms are contending with rising costs, defections of top advisers and uncertainties about regulations and new laws affecting the wealth management business.

Money managers and analysts who follow the wealth management business agree that the near-term outlook for 2013 is weak.

"Retail brokerage is a pretty good business but it's also a high fixed-cost business unless they stop paying their advisers," said Brad Hintz, an analyst at Sanford C. Bernstein. "Until investors come back, it won't be great."

RAIDS AND RIAs

Broker compensation, particularly for top advisers lured by seven-figure recruiting bonuses, remains a sore point for big banks that have been cutting costs and personnel in their traditional trading and banking businesses.

Morgan Stanley, Bank of America Corp's Merrill Lynch, UBS AG's UBS Wealth Americas and Wells Fargo & Co's Wells Fargo Advisors, the four biggest U.S. brokerages, lost at least 578 advisers managing more than $79 billion in client assets in 2012 while adding 375 with $48.4 billion of assets, according to Reuters data.

While about half moved to another big brokerage, the rest moved to smaller firms or became independent registered investment advisers, taking with them at least $35.2 billion in client assets.. The RIA share of retail client assets is expected to grow 14.4 percent by the end of this year from 12.2 percent in 2011, according to Cerulli Associates.

Discount brokerage firms such as Charles Schwab Corp and TD Ameritrade Holding Corp, often viewed as proxies for retail investor confidence, are benefiting from the exodus to RIA firms because they have major businesses servicing RIA accounts.

But the discounters also are anticipating a slow start to 2013. Active retail traders and investors who trade through discount brokers fear that stasis in Washington over debt ceiling limits and budget cuts could ignite a default of U.S. government debt and trigger market chaos, said TD Ameritrade Chief Executive Fred Tomczyk, and are likely to be on the sidelines at least through March.

Even if trading ignites, the Federal Reserve is expected to keep interest rates at record lows, depressing the net income brokers book from margin loans to clients and from investing.

Discount brokers also have been foregoing hundreds of millions of dollars of fees for money-market fund investors who would have negative returns if the fees were imposed.

That ripples out to the large brokerages. The wealth management division of Morgan Stanley, for instance, will not produce a 15 percent profit margin until the third quarter of 2014 despite a promise of hitting a "mid-teen" goal by mid-2013, according to Bernstein's Hintz. Thin profitability hurts because about 40 percent of Morgan Stanley's net revenue has been coming from its retail clients, he said.

A Morgan Stanley spokesman said the company stands by the mid-teen goal set for the middle of this year, but declined to define "mid-teen" or comment on Hintz's forecast.

REGULATORY OVERHANG

Also complicating this year's outlook for wealth management firms are new and proposed regulations.

The Financial Industry Regulatory Authority is considering a plan that could require brokers who move to a new company to disclose signing bonuses of $50,000 or more to clients they ask to move with them. [ID nL1E9C88U6] The plan, which may also apply to other types of bonuses, complicates what many say is already a challenging task for brokers. That is because colleagues at the broker's old firm are just as busy trying to keep the money at the company.

FINRA also is expected to ramp up scrutiny this year of a new rule requiring brokers to ensure that investment recommendations are suitable for clients at all times, not just when they make a trade. The rule, which took effect in July, has already increased costs vis a vis new technology to improve real-time monitoring of client accounts.

Also looming is a revised rule proposal from the Department of Labor that could restrict some brokers' ability to charge commissions when recommending investments in Individual Retirement Accounts and other retirement plans. The department withdrew its proposal last year after backlash from the brokerage industry but said it will issue a revised rule this year.

Brokerage firm executives also are lobbying to discourage Congress from removing or limiting the tax deductibility of municipal bond profits - an investment class some say is vulnerable amid Washington's deficit-cutting debate.

One area of good news for wealth managers: Fees tied to managing client assets have been rising - in part because they are tied to asset values and not to trades for commission - and are expected to continue their upward climb throughout 2013.

"The outlook is medium to good, especially relative to recent years," said Charles "Chip" Roame, managing principal of consulting firm Tiburon Strategic Advisors.

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