Firms are Shifting their Business Models, and Advisors Can Exploit this to Grow AUM

Merrill Lynch and Morgan Stanley maybe signaling a new reality for Advisors, but it’s not all bad news!

The move by Merrill Lynch and Morgan Stanley over the last week to change the way they report the number of Advisors on their respective platforms is a shot across the bow, a warning shot to Advisors of what’s to come.

Few have fully understand how consequential this change is for the industry.

We believe that many of the large full service or bank owned firms will soon follow.

In Canada for example, firms like Scotia Wealth, TD Private Wealth and CIBC Wood Gundy have already started to position their platforms for these changes.

But Merrill Lynch is the Role Model for Other Firms

In the case of Merrill Lynch, there’s been a curious silence over the last year, for a large firm, they’ve shown very little interest or strength in their recruiting efforts.

Merrill is traditionally one of the most aggressive in the industry, since the start of the pandemic there’s been a steady departure of Advisors to other platforms. For the 12 months leading up to March 2021, Merrill’s headcount dropped by a staggering 585, what is even more concerning is that 295 of those left in the first quarter of 2021. 🆘

“Merrill is projecting low single-digit growth in the number of its advisors annually over the next five years” - Management

For 2020 Merrill stood at the bottom of the list, that is of approximately 402 Wealth Management firms in the US, when ranked around recruitment.

Approximately $57.7 billion of AUM left the Merrill platform, to find new homes- at independent Regional Firms, RIAs or as breakaway Advisors that ventured out on their own to start new RIAs. As of March 31, 2021 overall headcount is still a whopping 19,808 Advisors, but markedly down from 20,393 in March 2020 (this headcount including Merrill Lynch, Pierce, Fenner & Smith Incorporated and Bank of America Private Banking and Investment Businesses).

But these numbers are being eclipsed by Merrill’s strong performance otherwise. So far this year, Merrill has reported first quarter 2021 Revenues for Wealth Management of $4.2 billion, added 6,400 new households and boasting record client balances of $3.5 Trillion as of March 2021, up 31% year over year. Still an incredible monster business in the industry.

However, just about $15.5 Billion of AUM left the firm in Q1 -2021.

Merrill is a bit of an anomaly, in some ways it still feels like they’ve completely abandoned ship on the Wealth Management. In 2020 they recruited a grand total of 120 rookies, but, eventually these were moved to administration roles within the firm, so zero effort to grow the Wealth Management Advisors headcount - What The F@#% are they thinking?🤯

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Clearly the Pandemic did not prevent recruitment activities at some firms in 2020. What’s evident, is that Advisors were also able to negotiate some serious recruitment bonuses from independent and regional firms, in some case up to 5x their revenues for some of the largest AUM Advisories, when all comps and bonuses are accounted for.

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Is a Single Private Banker Recruit a Signal For Change

There’s one peculiar recruitment transaction that is getting some attention, last week Barron’s reported that Merrill had recruited a private banking team away from CITI, managing $17 billion for UHNW and Family Offices.

But let’s just think about this for a second, is $17 billion really $17 billion AUM? Not so sure when it’s Private Banking business. 🙄

Yes, “Private Banker” (PB) and this is where the lines start to blur, some would say that its about Assets and Revenues, and that’s probably right, but, the economic model of “Private Bankers” vs. “Advisors” is quite different.

How different, well Firm’s tend to keep substantially greater portions of revenues generated by “Private Banking Groups” than they would through Advisor generated revenues in Wealth Management. So therefore, it is about efficiencies of Revenue generation after all.

But also the activities of Private Bankers are different from Financial Advisors, and Private Banking assets tend to be far more sticky because there’s more banking and less Advising, i.e. for many family offices a Private Banking relationship involves activities that often fall outside of the scope of Financial Advisors, taking the term holistic to another level.

At most large Banks, the role of a Private Banker centers around expanding the banks various services to the clients, everything from Credit Card Products, various forms of Leverage and Loans (lots of Loans), Hedging strategies and Proprietary Investment Opportunities.

But for Family Offices, they view a Private Banker in a different light, as a conduit to access the Bank’s capital, to assist in executing Family Office sponsored transactions, access to syndicated loan structures that can enable acquisition of Real Estate and Corporate assets, F/X for foreign transactions, or hedging.

Family Offices tend to have their own expertise in house, do their own analysis, have their own idea origination and are therefore less dependent on ideas driven by brokerage research, they tend to structure their own transactions and tend to focus more on private equity transaction and off market transactions or utilize sophisticated bespoke solutions to access public markets.

Much like the Total Return Swaps used by Archegos Capital that ruined it last month for many large prime brokers, and wiped out $5.5 billion off of Credit Suisse balance sheet, well that’s just one example, probably many other structures - highly levered or bespoke credit default swaps and highly customized derivatives etc.

But unlike the typical Advisory Fees or commission earned by Advisors, Private Banker revenue streams vary. Most Private Banker earn a flat annual salary, with further incentives linked to successfully arranging certain loan transactions or bonuses related to newly created transaction structures and volumes.

Unlike AUM fees, the Private Banker do not often earn fees to have cash or investments sitting in a bank account, so it comes down to facilitating transactions for their clients. However, the margins for the firm tends to be much higher for these clients, as transaction origination fees, spread on loans, f/x or hedging transactions can be very lucrative, particularly when these transaction tend to be repeating constantly, the good old churn -🎡.

So while Advisors tend to spend their time around financial planning, trust & estate planning, retirement, 401(k) and asset allocation etc. the private banker is, well a banker. Those Private Bankers in Miami would likely also focus a fair bit on dealing with foreign international family offices, after all Miami is the gateway to Latin American wealth.

Client Ownership Is An Important Differentiator for Advisors

One of the greatest distinction between a Private Banker and a Financial Advisors, is Client Ownership, many would argue that because of the nature of the transactions being facilitated by the Private Banker, the clients are more tied to the organization than the Individual.

$17 Billion is just a BIG HEADLINE 🥱

My point is here is that while the headline around Merrill recruiting a team managing $17 billion for UHNW and Family Offices, might seem like a huge turn around, its likely far from that.

Transitioning this $17 billion will be a momentous task, that will require the Family Offices to unwind the many loan agreements, hedging arrangements, SWAP agreements, collateral agreements etc. that are in place with CITI. Unlikely to happen in the near term, probably the best outcome here is a gradual transition into new arrangements with Bank of America / Merrill Lynch.

Smoke and Mirrors

Merrill has hinted that their recruitment efforts will be directed at Advisors who serve the UHNW, Family Office and HNW and they will concentrate on existing Advisors on the platform rather than a push to recruit outside Advisors.

But the true objective here - is to accelerate integration of Banking and Brokerage businesses. A direction that many Bank Owned firms have been moving to more aggressively.

What’s really at play as well is a gradual transition to centralized management, larger AUM practices and a consolidation of Assets internally - as this approach becomes adopted by more firms.

Advisors should pay attention. Consolidation internally increases the likelihood of gaining access to AUM acquisition opportunities.

Is the writing on the Wall?

Why are Merrill Lynch and Morgan Stanley changing the way they show Advisor headcount? And what’s the impact or Opportunity for Advisors?

The Pandemic has supplied these firms with an excuse to strategic reorganized their business models around Banking & Wealth Management. It’s not all roses for Advisors either, but there’s a great opportunity being lined up for some astute Advisors.

By grouping Wealth Management and Private Banking headcount together, these firms will be able to also focus on consolidating AUM internally. This move will encourage larger AUM practices and teams, the bar is gradually moving higher for those with smaller AUM practices, and eventually these Advisors will have only two options

1. Grow Quickly to keep up or

2. Move to a competing platform with better incentives.

Who wins, who’s losing and how do you exploit this see change

For the past decade the transition to RIA channels away from traditional brokerage platforms has been prevalent, and recently this move has accelerated even more.