Anyone reading the business sections of newspapers and magazines these days would be hard pressed not to draw the conclusion that the full-service brokerage industry is withering away and heading full steam toward extinction. Even as markets boom, the coverage frequently implies that American investors are deserting traditional broker/dealers faster than first-class passengers on the Titanic. The retail market may be hot, but it's the discounter, and the newer electronic virtual brokerages, that are reaping the big benefits.
It's not that on-line trading isn't growing, nor that it isn't having an impact on more traditional brokerages, but that impact may not be as great as the news stories and the hordes of industry analysts often make it appear. In fact, according to many of the most quoted consultants, the reports of the death of brokers and full-service brokerage, to paraphrase Mark Twain, may be greatly exaggerated.
"There is a perception out there that the rapid growth of on-line brokerage is coming directly at the expense of more traditional firms. That, however, may not be true," says Michael Gazala, an analyst with Forrester Research in Cambridge, Mass.
The number of trades executed each month by on-line brokers has been steadily increasing. A recent report by Piper Jaffray regarding the on-line trading industry bears that out. The on-line industry generated an average of 153,000 trades per day during the fourth quarter of 1997, up 60% from the first quarter of the same year. Further, the report states, the on-line trading industry generated an estimated 17% of all retail trading activity in 1997, more than double the share for 1996.
Similar reports by noted consultants such as Gomez Associates, Tower and Cerulli have all indicated the same clear and obvious trend. But there is one key piece of essential information most consultants admit to lacking--exactly who these on-line traders are.
"The news coverage of the industry leads you to believe they are full-service customers abandoning their brokers in favor of newer services, but we don't know that," says Dennis Gallant of Cerulli Associates in Boston.
Even Bill Burnham, author of the oft-quoted Piper study says the numbers of clients who actually close full-service accounts to transfer to lower cost providers probably represent a small segment of the on-line industry's growth.
"I know this because firms sometimes share the records of ACAT transfers with me and there just doesn't appear to be a lot of movement in this area," Burnham says.
So, if the on-line sector isn't directly pulling established customers away from their brokers, then it must be grabbing them before they even get to the full-service firm.
"Maybe," says Gazala. "But the number of on-line trades is really more indicative of how active traders are, rather than how many of them there are. Even as these firms tout huge growth in new accounts, we can't say how many of those are really active traders."
In fact, for all the inroads made by on-line trading, business for retail brokers, according to data from the Securities Industry Association, has never been better. According to their most recently released figures on broker compensation, booming markets helped boost average gross commissions and fees for retail reps by 18% in 1996 compared to the previous year. Average gross commissions and fees were $358,789 in 1996, up from $305,876 the year before.
A New Market It may well be that many of the on-line customers, while clearly a growing number, do not yet represent the kind of older, more affluent clients that are on every broker's A list.
"There are many good potential clients out there trading with E*TRADE, I'm sure," says one veteran Merrill Lynch broker. "But on the whole, I think it may be a class of investor that isn't ready for Merrill anyway."
Lawrence Silver, vice president of marketing for Florida-based Raymond James seems to agree. According to Silver, many of the customers of on-line services don't possess the asset size that his firm's brokers look to acquire.
"Don't misunderstand, we want and welcome the business of younger investors--the whole industry does--but I'm not sure customers of many electronic discounters would have come to us at this stage of their lives even if this other channel didn't exist."
Silver also says some of the attention paid to the continual stream of numbers showing the growth of on-line firms appears to him to be somewhat misunderstood. "Most of the reports show the competitive position of one discounter in relation to another, not in their relation to our firm," he says.
That, in essence, appears to be true. Much of the news coverage of analyst and consultant reports highlight the monthly competition for the top stops among on-line trading firms--how Schwab is holding up in relation to E*TRADE and Waterhouse and DLJ Direct.
"This probably leads to some misconceptions," says Gallant. "Especially the idea that as one sector grows, the other shrinks." No one, Gallant says, really knows if that is the case.
"We know both parts of the industry have had an effect on one another, but exactly what that effect is we don't know," says Richard Thornblad, the Security Industry Association's vice president of sales and marketing services.
According to Burnham, the growing number of on-line trades comes from several places, including many new equity investors, those who have previously been in no-load mutual funds and now are trying their hand at stocks.
"Will they stay with these firms? Will they even stay in the equities market if things change? Who really knows?" Burnham says.
That may be the million-dollar question. No one, not even the electronic discounters themselves, dispute that some of their success is based on an almost unnatural stroke of luck, the Internet's coming of age while markets reached unprecedented sustained highs. That combination has clearly attracted millions of new investors to the industry, a significant percentage of whom have never seen a bear market and believe there is nothing to making money in the market beyond logging on to their PCs and hitting some buttons.
Where will they be when the market turns? It is not difficult to envision many leaving the market when that happens, and many others deciding a little seasoned advice is in order.
"But you won't see the opposite scenario," says Gazala. "Full-service customers in a down or skittish market aren't going to suddenly decide it's time to do it yourself."
In fact, "The big industry trend you see is electronic [trading firms] and discounters trying to provide as much assistance to their clients as possible" says Julio Gomez, an electronic trading consultant.
Even among no-load mutual funds, a significant percentage of sales now are occurring through fee-based or adviser channels. And for every ad or press release highlighting the low cost of using a discounter, there are twice as many highlighting the research and even auxiliary support services they now offer.
"These firms know that after clients reach a certain income, a certain age or even after some of the novelty wears off, they are going to look for advice and they are afraid many will run to the nearest broker," says Silver.
Silver adds that he's heard more than one consultant say that Schwab still loses more of its customers to Merrill Lynch then it does to all the other discounters.
"Things have gotten to the point that when you look at the services offered by most of the discounters and no-load fund companies, they are looking a lot more like us each day," says one Salomon Smith Barney broker in the Midwest.
"It may turn out that on-line firms are the full services industry's best friend, providing us with a feeder service down the road" says Silver.
