Are smaller investors getting the boot?

Over the last few years, “wealth-management business expenses have escalated dramatically for both small and large investment dealers,” says Ian Russell, president and CEO of the IIAC, in his latest letter.

And, these costs will largely be passed on to consumers via higher commissions, fees and charges, he adds, noting, “The higher-end client will pay more for customized and value-added products and services, [while] the small investor will pay higher charges and face more limited advice options.”

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One reason business expenses have spiked is firms are dealing with the fixed costs of technology and regulatory compliance demands, including those related to CRM2. At the same time, says Russell, “the competitive pressures on independent institutional and retail firms have intensified, as business conditions have remained weak.”

This is a major issue for smaller clients, in particular, says Russell. He predicts firms will transition such investors to what he calls a utility model. This means “clients with smaller accounts and less portfolio activity” will get fewer investment options and less customized service. They’ll also be directed toward automated options, such as self-directed and robo accounts.

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What’s concerning, he says, is this shift is occurring when investment returns are constrained and retirement-savings tips are crucial for middle-income investors.

But investors haven’t yet given up on advisors. Says Russell, “The wealth management business has expanded steadily in the last five years in response to strong client demand.”

Consider these figures: “Three years ago, the fees from discretionary managed and advisory accounts approximately equaled brokerage commissions in the industry,” he adds. “Fee-based earnings now dominate, with overall fees more than one-third higher than stock commissions.”

Interestingly, there’s also been a steady pronounced increase in mutual fund sales and commissions, says Russell, despite the current focus on fee disclosure. “The popularity of mutual fund investments among the relatively sophisticated clients of IIROC-registered dealers has happened despite increased publicity about high-cost mutual funds.”

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In fact, mutual fund commissions, including trailing commissions, increased 10% year-over-year in 2015, after posting a 6% gain in 2014 and a 12% increase the year before. The IIAC says this growth is due to both the popularity of the funds and the appreciation of their assets. Both factors have pushed mutual fund assets to historically high levels, but the actual commission rates levied on mutual funds and the rates paid by fund manufacturers on trailers has been relatively unchanged.

Still, what’s likely to occur “is the mutual fund channel will continue to integrate into the IIROC dealer platform, driven by the need for scale,” says Russell. “The managed fund industry will continue to consolidate as the mid-sized and large players […] swoop up smaller investment funds.”

Futher, due to the implementation of the final phase of CRM2, clients may move away from mutual funds going forward. For example, investors may shift “to a different mix of product and services, and some clients [may] move to another advisor and firm,” or rely more on self-directed accounts.

Russell expects this shift “will be concentrated among the small investors invested in mutual funds.”

Recent industry performance

Following two years of back-to-back earnings gain, overall operating profit for Canada’s investment industry declined 13% year-over-year in 2015. This was due to declining investment banking revenue, and setbacks in fixed income and equity trading revenue, says Ian Russell of the IIAC. Plus, the climb in operating costs cut into operating margins.

Overall, 2015 saw a 14% year-over-year decline in investment banking revenue for the industry.

However, the financial picture improved by the end of Q1 2016, says Russell, as financial market volatility decreased and global oil prices moved off of lows. First quarter investment banking revenue was up 22% for the industry, compared to the fourth quarter 2015, with improved conditions continuing through mid-year.