Once upon a time, the investment business was more of a cottage industry. Portfolio manager and investment broker were ‘professions’ rather than jobs. Smaller independent firms specialized in looking after their clients’ savings. There were no investment ‘products.’ The landscape began to change dramatically – in 1988 RBC bought Dominion Securities, CIBC bought Wood Gundy and so on – when the banks decided to diversify away from lending and began their move into investment banking, wealth management and mutual funds.
Take mutual funds for example. Over the past few decades Canadian banks have continued to grow their share of total mutual fund sales* – this should not surprising since by acquisition and organic growth in their wealth management divisions they now own the lion’s share of the distribution networks (bank branches, brokerage firms, online trading).
An added strategic advantage most recently has been the capability of the banks to successfully market fixed income funds since the financial crisis. Risk averse investors want to preserve their capital and have embraced bond and money market funds as well as balanced funds while eschewing equity funds altogether. With waning fund flows into stock markets, how can equity valuations rise? It’s a self-fulfilling prophecy.
Many of the independent fund companies, born decades ago during times when bonds performed badly (inflation, rising interest rates) and stocks were the flavor of the day, continue to focus on their superior equity management expertise. Unfortunately for the past few years they are marketing that capability to a disinterested investing public.
The loss in market share* of the independent fund companies to the banks continues unabated. Regulatory trends also make it increasingly difficult for the independent fund companies to compete. Distribution networks nowadays (brokers, financial planners) require a huge and costly infrastructure to meet compliance rules. Perhaps I’m oversimplifying, but once a financial institution has invested huge money in such a platform does it make sense to then encourage its investment advisers and planners to use third party funds? Not really! Why not insist either explicitly (approved lists) or implicitly (higher commissions or other incentives) that the bank’s own funds be used?
Stricter compliance has made it extremely difficult for investment advisers to do what they used to do, i.e. pick individual stocks and bonds. In Canada, regulators have made putting clients into mutual funds more of a burden in recent years.
To a significant degree, mutual fund regulations have contributed to the rapid growth of ETF’s (Exchange-Traded Funds). An adviser will be confronted by a mountain of paperwork if he recommends a stock – suitability, risk, know-your-client rules) or even a mutual fund. An ETF is less risky than a stock, and can be purchased and sold more readily in client accounts by trading them in the stock markets. Independent fund companies that introduced the first ETF’s did well enough for a time but not surprisingly the banks are quickly responding by introducing their own exchange-traded funds. For example:
TORONTO, ONTARIO–(Marketwire – Nov. 20, 2012) – BMO Asset Management Inc. (BMO AM) today introduced four new funds to its Exchange Traded Fund (ETF)* product suite.
In fact, the new ETF’s launched by Bank of Montreal grew 48.3% in 2011. When it comes to the investment fund industry, go big or go home! You’d think that Claymore Investment’s ETF’s would have it made with over $6 Billion in assets under management (AUM) but alas the company was recently bought by Blackrock, the largest money manager in the world with $29 Billion under management. It will be interesting to see if the likes of Blackrock will have staying power in Canada against the banks. After all RBC has total bank assets twenty-five times that figure. Survival in the business of investment funds, and perhaps wealth management in general depends on the beneficence of the Big Five.
Admittedly, the foray of insurance companies into the investment industry has been aggressive and successful for the most part. With distribution capability and scale they certainly can compete, but the banks have a huge head start. Most insurance companies are only beginning to build out their wealth management divisions. I can see a logical fit between insurance and investments from a financial planning perspective, but then the banks know this and have already begun to encroach on the insurance side of the equation. Nevertheless I would not discount the ability of the insurance companies to capture signficant market share.
So, is it a good thing that larger financial institutions own the investment industry? Consider the world of medicine. No doubt a seasoned general practitioner will feel nostalgic for days gone by when patients viewed them as experts and trusted their every judgement. The owner of the corner hardware store no doubt holds fond memories of those days before the coming of Home Depot. Part of me wants to believe that investors were better served before the banks stampeded into the industry but I’d just be fooling myself. Although consolidation has resulted in fewer but more powerful industry leaders, the truth is that never before have investors had so wide an array of choices. Hospitals today are filled with medical specialists, while banks and insurance companies too are bursting at the seams with financial specialists.
It is not fun becoming a dinosaur, but this general practitioner has to admit progress is unstoppable.
*The industry charts are courtesy of the third quarter Scotiabank research report Mutual Fund Review. The annotations are my own.