Stockbrokers are going extinct. Wall Street hasn’t trained a real stockbroker in nearly 20 years. Today, stockbrokers have been replaced with “financial consultants” (or whatever they choose to call themselves) who do nothing more than gather clients’ assets, outsource the actual investment management to third parties, and collect fees.
Is the demise of the stockbroker a good thing for investors? We say no, it’s very bad.
Stockbrokers get “Gorman-ized”
Roll the clock back to the mid 1990s, a time when retail commissions were spiraling downward. For firms like Merrill Lynch, it was a serious situation as their brokerage units were highly dependent on commission revenues. Additionally, their sales forces were growing to the point that it was getting increasingly difficult to supervise them. Who did Merrill turn to? Who else but the famed consulting firm McKinsey & Company.
With the help of McKinsey, Merrill set out to persuade regulators to allow brokerage firms to offer asset-based fee accounts (in lieu of commissions), something that brokerage firm weren’t allowed to do at that point. After some slick regulatory footwork, in 1999 the SEC adopted a de facto rule allowing these new fee-based brokerage accounts, and not surprisingly that rule became known as the Merrill Lynch Rule.
Working at McKinsey on the Merrill account in the 1990s was none other than James Gorman, the current Chairman and CEO of Morgan Stanley. In 1999, Merrill hired Mr. Gorman to run its marketing department and to oversee the new fee-based strategy. Mr. Gorman eventually went on to run Merrill’s sales force, successfully converting Merrill’s stockbrokers into this new breed of asset gatherers. In many respects, fee-based brokerage accounts are the brainchild of James Gorman.
Mr. Gorman’s solution for Merrill Lynch was brilliant. Under this new model, Merrill’s brokerage unit would have predictable and stable revenues. It was also much easier to train new brokers to pick out mutual funds than it was to train them to actually buy stocks and bonds for customers (and easier for the compliance department too).
Like most of Merrill’s innovations, fee-based brokerage accounts took off like wildfire. But as brilliant as this new model was for the brokerage industry, investors have been harmed. This new business model was designed to benefit brokerage firms, not investors.
Life after stockbrokers – it’s the investors who suffer
Frustrated investors complain to us all the time that they have very limited investment alternatives – they can either use high cost active managers (mutual funds, separate account management, hedge funds, etc.) or low cost index funds. What investors are slowly figuring out is that active management simply doesn’t work as advertised.
Last week, S&P published its 10th Annual Mutual Fund Performance Report. According to the report, 84% of actively managed funds did worse than their respective indices, and a staggering 96% of large cap growth funds (that’s almost all of them) failed to beat their benchmark. The longer-term numbers aren’t much better. So, by default, indexing has become the logical choice for most investors.
But what ever happened to individuals putting together their own investment portfolios? That’s right, actually buying stocks and bonds in a brokerage account. That cost effective option has gone the way of the stockbroker, and most investors don’t even consider it an option.
The sad reality is that in a world without stockbrokers, investors are reluctant to take the plunge and buy individual stocks and bonds. Granted, some will tune in to the Jim Cramer show and watch him breakdown six stocks in 60 seconds and give it a try, but these people inevitability confuse investing with short term or day trading. Real investors don’t treat their investment portfolios like a game show.
Does he eat his own cooking?
We think that investors need to take back control of their investment portfolios and learn how to invest in a portfolio of individual stocks and bonds. And that’s where a trustworthy, good old-fashioned stockbroker is worth his or her weight in gold.
Mr. Gorman changed Wall Street, and that’s not an easy thing to do. We wonder if Mr. Gorman eats his own cooking. Is his personal investment portfolio chock-full of these high cost, underperforming investment products?