In his latest letter to the industry, IIAC president and CEO, Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC) notes that overall, the industry’s performance “has been remarkably solid” for the past few years. On aggregate, the industry is averaging a return on equity (ROE) of 8.4% over the past four years.
However, there is wide disparity within the industry. “Performance at the large integrated and mid-sized retail independent franchises has held up relatively well over the past three years,” Russell says. “Independent institutional firms and small retail firms have had mixed results, but on balance recorded relatively poor performance.”
The IIAC reports that retail boutiques have averaged ROEs of 7% over the past few years, but introducer firms returned 9.9% over the same period. On the other hand, the domestic institutional firms averaged a 3.1% return, which has led to some attrition in that part of the business.
Indeed the retail business has emerged as a pillar of strength over the past several years. The IIAC reports that retail revenues in the industry have grown at an 11% average annual rate over the past three years, with both large and small firms enjoying, “… sustained expansion in retail demand for financial products and advisory services. ” This is so despite weak economic growth, low interest rates, and heightened market uncertainty.
This resilience, the IIAC letter says, reflects growing demand for advice and products to bolster retirement savings, and to manage the baby boomers’ shift into retirement. As a result, “The retail advisory business has become even more the dominant business line in the industry,” the letter says, noting that it now accounts for about 60% of overall industry revenues.
In particular, revenue from fee-based accounts has soared over the past couple of years, the report notes. “Fee-based accounts now represent an estimated 80% of client accounts,” it says, adding that revenues have almost doubled over the past five years to $6 billion in 2016. “The regulatory scrutiny of investment suitability, and conflicts of interest from the coming Best Interest Standard, will accelerate the shift to fee-based accounts from transaction accounts,” it says.
Yet, while retail has been rocking, other parts of the business have had their struggles in recent years, the IIAC says. For instance, venture financings have yet to recover to their pre-crisis levels. Companies in the resource sectors have been particularly hard hit, amid lower global commodity prices. Structural shifts in the industry — including reduced investor demand for junior equities, and the demise of small, venture-oriented dealers — are also hurting this segment of the business.
“This erosion in the vitality of the venture public markets is a serious concern for Canadian markets and the health of the small business sector,” the letter says. “Mid-sized Canadian businesses are dependent on access to these public markets to supplement, and often displace, private venture capital to expand and grow to meet domestic and foreign business opportunities.”
On the cost side of the equation, the IIAC reports that industry operating costs have grown at an average annual rate of about 5% over the last three years, with both large and small firms seeing similar increases. It expects these costs to continue rising, amid rising regulatory expectations and intensifying competitive pressure to invest in technology.
Looking ahead, the IIAC suggests that the pace of growth in the retail business is set to slow. “The unprecedented gains in revenue from the wealth management business will likely moderate over the next year or two,” it predicts. “The biggest impact on the retail business will be a slowing in fee income as mid and high-income baby boomers move further into the pre- and post-retirement phase and the portfolio adjustments and financial planning needs for retirement are completed and eventually stabilize.”
Additionally, it says that the bull market is “likely to lose momentum”; and, that competition will pressure fees. As costs continue to rise, operating margins will eventually be squeezed too, it predicts.