Between the rise of robo-advisors, the demise of the venture market and the ceaseless complaints about regulatory burden, the investment industry may appear to be facing its fair share of struggles. Yet industry profits are rising steadily, fuelled by a boom in retail investor fees.
The latest data from the Investment Industry Association of Canada (IIAC) reveals that, overall, the investment business is in fine form. Although there may be areas in which firms are struggling, the industry's overall bottom line is undeniably strong.
Through the first half of 2017, total industry operating profit was about $3.07 billion, more or less in line with the $6.3 billion that the industry generated in all of 2016. This also represents a healthy gain over the past few years, as annual industry operating profits were less than $4 billion in 2013.
Aggregate net profit is about $1.7 billion for the first six months of 2017, a figure that's also in line with last year's results. In 2012, net profits barely topped $2 billion for the entire year.
A big reason for the investment industry's remarkably healthy bottom line is the resilience of the retail investment business - even though certain institutional firms and the venture market have had their struggles.
At the 10 large, integrated firms - which includes all of the major investment dealers - operating profits rose to $5.2 billion in 2016 from $3.3 billion in 2013. During that same period, operating revenue surged to $15.2 billion from about $11.8 billion.
Yet, for these firms, revenue from commissions is more or less flat, trading revenue is down and corporate finance revenue is up only slightly. The big driver of revenue increases over the past few years is fees (such as asset-based account fees), which rose to $4.7 billion in 2016 from $2.8 billion in 2013. This year, revenue from fees is on track for continued double-digit growth rates.
Through the first half of 2017, fee revenue at the integrated firms totalled more than $2.7 billion - more or less what the industry generated from fees in all of 2013. This year, the big firms are in line to collect around $5.4 billion in fees from investors.
Although Canada's large investment dealers enjoy several advantages - including scale, brand recognition and the promise of stability - this heady growth in fees isn't just a phenomenon among the large firms. In fact, the trends are similar among the industry's small retail firms.
In 2013, the retail boutiques collected about $675 million in fee revenue; last year, that figure rose to $1.05 billion. And, in the first half of 2017, these firms already generated $615 million in fees, indicating that this year is likely to produce continued strong growth in fee-driven revenue.
Profits for these firms look set to climb as well. In 2016, the investment industry's retail boutiques generated $319 million in aggregate operating profits. Through the first six months of 2017, these firms have booked $242 million in operating profits - setting up a healthy increase in the bottom lines for these firms this year.
Even the industry's smallest players - retail introducing brokers, a subset of the retail boutiques - are not being left out. Their operating profits jumped by 33.6% last year and fee revenue rose by 20.6%. Through the first half of 2017, both metrics are on track for continued strong growth.
These trends come at a time when investment fees should be under intensifying pressure. The slow growth, low-return environment that has prevailed in recent years magnifies the negative impact of investment fees on portfolio returns.
Moreover, clients are better armed to understand the magnitude of their investment costs, thanks to the implementation of the second phase of the client relationship model (a.k.a. CRM2), which dramatically increases the disclosure clients receive regarding the costs of investing and the underlying performance of their portfolios.
In addition, the apparent success of robo-advisors, which pitch themselves as low-cost alternatives to the traditional, full- service brokerages, suggests that clients are increasingly sensitive to the impact of fees on their portfolio returns. Even so, this emerging competition doesn't appear to be having much of an effect on the industry at large.
According to the IIAC's figures, fees now represent more than half of overall retail revenue, up from less than 40% just a few years ago.
The trend toward fees in general, and fee-based accounts in particular, has been evident in the investment industry for some time. The data from Investment Executive's annual Report Card series has long pointed to a general shift away from commission-based revenue and toward fees throughout the investment business. The trend is strongest among the big brokerage firms and individual top-performing brokers.
For firms, advisors and clients alike, the central appeal of fees is that they appear to do a better job of aligning their respective economic interests. When clients' assets increase, so does industry revenue. Fees also eliminate the incentive to trade excessively or "churn" clients' accounts. Many firms also prefer the stability of fee-based revenue vs the volatility of relying on commissions.
Yet, investor protection concerns stemming from the shift toward fee-based accounts also have arisen. Much of the widespread overcharging at the big bank-owned dealers that led to recent no-contest settlements with the Ontario Securities Commission (OSC) involved clients in fee-based accounts paying embedded product fees on top of account fees.
At the same time, the Investment Industry Regulatory Organization of Canada's (IIROC) recent review of compensation-related conflicts of interest also flagged a concern with firms indiscriminately shifting clients into fee-generating accounts without ensuring they make the most sense for specific clients.
IIROC's review found that firms are pushing their brokers to put clients into fee-based accounts by providing both the maximum grid payout for these accounts along with performance bonuses connected to assets under management held in these kinds of accounts.
"Our concern is that clients may be moved into fee-based accounts, whether or not such accounts are consistent with the client's best interest," the IIROC review states.
The review also raised concerns about the same double-charging the OSC has uncovered and indicates that disclosure concerning these types of conflicts often is inadequate. IIROC has issued additional guidance to firms in response to the findings of its review and pledges to step up scrutiny of these areas during investment dealers' compliance exams.
Whether this heightened regulatory scrutiny will end up denting the powerful growth of fee-based revenue is unclear. The IIAC anticipates growth will slow as markets inevitably lose steam and demographic forces mean investor demand for wealth-management services ebbs.
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