I had an interesting conversation with an old friend who has been working at a giant bracket firm his entire multi-decade career. What makes this particular conversation interesting is his sudden epiphany about the sell-side.
Our previous discussions (debates really) were over the traditional model of brokerage which I turned against fee-based fiduciary asset management. My examples of overpriced, under-performing, abusive account management are derided as outliers. His counter is that responsible brokers (like himself) run a transactional business for clients who want these services. He has high client retention and has produced respectable performance for those clients.
The reason for his realization is the exit from his firm by a senior broker. As often happens in these situations, the former employee’s books are split among the remaining brokers, whose job it is to hold those accounts and their assets that weekend. My friend manages several million dollars and has avoided this aspect of the business. He is old enough to take part in this traditional sail-side feeding frenzy. But since it’s late summer, and there’s light employee availability, he’s assigned some accounts to call on.
What he saw shocked him:
The previous broker outsourced much of its asset management to third-party managers; Digging into the details: Sub-$1m accounts charged 1.25% for high turnover, actively managed SMAs that trailed its benchmark by several 100 basis points.
Where things got really wild was the details of the SMA: over 200 holdings, many of which were one or two shares. Turnover was also mind-boggling: 800 transactions a year; If we assume one sale for every purchase, that’s still a >200% turnover rate (and there’s still 4+ months left in the year).
He was angry about this. This made me laugh, as we have discussed this level of inappropriate and inappropriate asset management over the years, offering an endless parade of my examples. But since that’s not how he runs his clients’ money, his guess was that my examples were the worst of the worst (and they often, but not always). Now after studying this book of business, asking questions of other brokers and managers, he realizes that this is how the far more sell-side handles a significant portion of his customers.
We discussed closet indexing and why owning hundreds of stocks seems pointless versus owning a broad index. Say what you will about Cathy Woods and ARKK, but a concentrated portfolio like hers makes more sense as a satellite to this unholy mess of high-value high-turnover SMAs versus the Vanguard Total Stock Market Index ETF (VTI) or the S&P 500 (SPY). makes .
I reminded him that the buy-side is regulated by the SEC, while the sell-side is self-regulated by an SRO.1 Indeed, the NASD-R’s history is one of an industry that works hard to avoid close oversight by the government and protect its largest members. It has historically always been the worst in conflict, anti-competitive behavior and anti-investor behavior. This was reflected in NASD-mandated private arbitration for disputes between investors and brokerage houses, which have a rich history of pro-industry, anti-investor bias and fraud. It would be a joke if it didn’t make so many investors out of their money.
But I disagree.
The sell-side has gradually come to fee-based asset management as opposed to transactional business. The joke is that BD used the “Net’em & Forget’em” business model instead of “Churn’em & Burn’em”.
This is not really a fair complaint. It’s a much cleaner business model to charge a reasonable fee for straight-up asset management and financial planning, rather than playing games like stock picking, sector rotation, market timing and the like. Doing so puts the odds in their favor, with the bonus that fewer regulatory headaches, legal liabilities and compliance issues occur – all of which more or less go away if you manage this type of model correctly.
Now if only the sell-side could get religious about fiduciary values, I’d stop hating them so much.
They can’t help themselves, because syndicates, leveraged loans, underwriting, annuity sales, investment banking, IPOs, wrap accounts and other forms of financial engineering have historically accumulated far more money for profit. Brokerage Firms.
Considerable progress has been made, driven not by government regulation, but by market competition. Registered investment advisors (RIAs) have moved trillions of dollars away from the sell-side and into a much more investor-friendly way of doing business.
It’s just a shame it took so long for many in the industry to notice…
Backstage Wall Street: An Insider’s Guide to Knowing Who to Trust, Who to Run, and How to Maximize Your Investments
in the past:
Bill Miller: Closet Indexers Are Killing Active Investing (October 28, 2016)
The first rule of running other people’s money? Do No Harm (March 20, 2016)
1. The SEC has oversight of both the buy-side and the sell-side, but most of the heavy regulatory lifting for the sell-side is done by the industry itself.
“Put some lipstick on this pig”