The recent turmoil in financial markets, sparked primarily by plunging oil prices, could undo some of the gains that wealth management businesses have made in the past year, suggests Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC). He sees more industry consolidation and forced adaptation to these, and other forces, in the year ahead.
In his latest letter to the industry, which reviews the slew of forces that have impacted the investment business over the past year — economic, regulatory, demographic and technological — Russell notes that much of the Canadian investment industry has recovered on the back of strong equity markets over the past couple of years. Although, this recovery has not been uniform.
“The larger integrated and boutique firms demonstrated relatively better performance given their advantage of scale to absorb rising fixed costs of technology for compliance and enable efficient front and back-office operations, diversity of product and services, and multiple channels to deliver financial services,” he says in his letter, noting that for the integrated firms, revenues and earnings now surpass pre-crisis levels.
At the same time, he says that while dealers with significant wealth management operations — including both integrated firms and retail boutiques — have benefited from strong market conditions, the institutional boutiques are continuing to suffer from weak conditions in their primary business lines.
Looking ahead, Russell doesn’t offer a comprehensive forecast for the industry in 2015 — he’s scheduled to deliver that in a speech to the Empire Club in Toronto on Jan. 8, 2015 — but he does note that recent market turmoil is expected to hit the retail business in the months ahead.
“Most recent economic and financial developments, particularly in the oil markets, have contributed to the onset of increased market volatility, the decline in share prices and heightened investor caution. Performance of the wealth management business will possibly deteriorate in coming months, as commissions and fee-based revenue fall from current levels in response to declining share prices,” he says.
Looking further out, Russell also notes that the industry will continue to grapple with regulatory reforms in 2015, including the coming on stream of further Client Relationship Model (CRM2) requirements; which, he notes, calls for further guidance from regulators. “The format of fees charged and advisor compensation, securities valuation issues and portfolio performance computation are complex matters, requiring clear direction from the regulators before technology can be developed and systems put in place,” he says.
At the same time, the industry is also dealing with the impact of demographic change, he notes — including the aging baby boomer generation on one hand, and the emergence of the so-called “millennials” on the other, who are coming of age in a time that has made them skeptical of the mainstream financial industry, and more open to relying on technological solutions.
“The challenge for the investment industry is to connect with this ‘internet generation’, a generation cohort that is technology savvy but skeptical of the savings-investment process,” he says. “One can reach them through social media — that itself presents compliance challenges to firms — but one will have difficulty convincing them to take financial advice.”
Amid these various forces, Russell also foresees more consolidation ahead for the investment industry. He notes that about one third of firms are still losing money, and that more than 20 shops have either closed their doors entirely, merged, or shifted to the exempt market, in the past two years.
“This consolidation will likely continue in coming years with the recognition many business models must change and adapt to the times given compliance and broadening client demands, and small firms must build scale to survive in today’s markets,” he says. “Moreover, this consolidation — not just among investment dealers, but across the financial sector — will accelerate as the demand for diversified products and services intensifies, and the final shoe of regulatory reform drops, notably the disclosure of embedded fees.”
At the same time, firms are facing increased competition from so-called “robo advisors”, which Russell notes, is one of the fastest growing segments of the U.S. wealth management business. This could also represent a strategic opportunity for smaller dealers, he says, allowing them to serve certain retail clients on a more cost-effective basis. ‘This could be the strategy to attract younger clients at an early stage to the investment dealer, migrating these clients over time to a more sophisticated personal advisory relationship,” he says.
The firms that survive this latest wave of consolidation will be stronger for it, Russell notes. “The boutique firms that are successful in building scale through acquisition of other dealers and advisors, and broadening their line of competitive products and services, will identify niche strategies and opportunities right across the financial sector,” he says; adding that higher-end clients and advisors at mutual fund dealers also represent an attractive growth opportunity.
Indeed, Russell once again proposes that the self-regulatory organizations (SROs) for the fund dealer and investment dealer businesses should merge, while maintaining their own rule-making and compliance responsibilities. “This SRO amalgamation would provide flexibility and yet deliver the benefits of more cost-effective regulation, and a level playing field for the distribution of mutual fund products,” he says. “These adjustments would promote efficient restructuring without damaging investor protection.”
“Dealers that can adapt to change, build and persevere with a vision and strategy, and seize advantage of technology, will see increasing opportunities to build successful competitive franchises in the financial sector,” he concludes. “The phoenix of a restructured and reinvigorated industry will rise from the ashes of the cyclical and structural battering that has characterized the investment industry in the post-financial crash era.”