The white flag of surrender hasn't quite been raised, but the war for the Canadian investor looks all but over.
Coming out of the financial crisis, the big banks and independent retail brokerage firms each had big ambitions to expand their businesses. The crisis and the stock market crash, they hoped, would bring opportunity; rattled investors would want help and advice on how to repair their battered portfolios and save their retirement plans.
Several years later, what seemed like an even-handed fight between the banks and their smaller independent rivals has become lopsided. And it's the Big Six that are winning.
It's a tough pill to swallow for someone like Andrew Marsh, who has been on both sides of the battle. For 12 years, he built a solid business as a retail broker in London, Ont., giving financial advice to a lengthy roster of loyal clients at Bank of Nova Scotia's investment division, ScotiaMcLeod.
But in 2004, he left it all behind to become one of the co-founders of GMP Private Client, an advisory shop created by investment bank GMP Capital Inc. to butt heads with the banks. It seemed like a good decision – until the market crashed.
Losing money, Mr. Marsh's firm merged with rival Richardson Partners in 2009 to bolster both companies' balance sheets. The combined entity, Richardson GMP Ltd., is still struggling, posting a loss in 2012. Canaccord Genuity Wealth Management, another independent, hasn't turned a quarterly profit in a year and a half. Small firms that generate most of their revenue from advising retail investors collectively lost $99-million last year, according to the Investment Industry Association of Canada.
The banks, meanwhile, are swimming in profits. Though they also suffered during the downturn, their wealth-management divisions, which sell mutual funds and other products to millions of Canadians, rebounded with incredible speed. Royal Bank of Canada's wealth division made $763-million last year, while Toronto-Dominion Bank's earned just over $600-million in the same period.
This is no accident. The banks have invested heavily in their asset management and financial advice operations, hoping these businesses can combat slowing growth in other units. Canada's housing market is cooling, making it harder to find growth in selling mortgages; revenues from investment banking and other high-end corporate businesses are volatile, and are now feeling the effects of the capital drought in the energy and mining sectors.
There's also an element of safety to the Big Banks' strategy. Since the crisis, banking regulators have been tightening up the rules for how much capital banks need to hold. The business model of wealth management is a simple one – it's about helping people to invest their money in return for a fee – so there's no risk of the kind of catastrophic trading losses that brought down major U.S. banks in 2008. For that reason, regulators don't demand that banks hold a large capital cushion against these units.
"Clearly, wealth is a nice offset to credit businesses and trading divisions that carry different risk profiles," RBC chief executive officer Gordon Nixon said.
Against this backdrop, banks are getting more aggressive. The acquisitions are starting to add up. Scotiabank scooped up independent DundeeWealth for $2.3-billion in 2010 and National Bank of Canada acquired Wellington West Holdings Inc., an independent brokerage, as well as HSBC Bank Canada's retail brokerage arm. The country's biggest banks now control nearly half of all the long-term mutual fund assets in Canada; by some estimates, they have 90 per cent of all the assets in retail brokerage accounts.
That leaves little for the four big non-bank brokerage firms – Canaccord Genuity, Richardson GMP, Raymond James Ltd. and Macquarie Private Wealth Inc. – as well as their smaller peers.
But while the numbers say that the banks look smart, the independents tell a different story. They argue that the Big Six are using their natural advantages – their size, deep pockets and vast networks of bank branches on street corners everywhere – to push them aside. Mutual fund companies are also feeling the pain, as banks continue to take away market share from the likes of AGF Management Ltd. and others.
Some believe the Big Six are in the process of conquering the asset-management industry – just as they swept up independent investment dealers and trust companies in the 1980s and 90s. That may turn out well for bank shareholders, but it also represents an even greater concentration of market power in a small number of already-powerful institutions.
"Every step of the way," Mr. Marsh says, "the banks are very active in telling people that there's no way we can make it."
Banking is an industry rife with buzzwords. When you ask bank executives about the gains they are making in the wealth-management business, here's one they are likely to use: "open architecture."
The term refers to the selection of financial products they are willing to sell to clients. "Open architecture" means that they sell not only their own funds, but those of other companies.
"There's no doubt we have open architecture," said Dave Agnew, head of Canadian wealth management at Royal Bank of Canada. "We do not force any product, whether it's in-house or not … to the clients within our wealth businesses in Canada."
Generally speaking, that's true. Bank-owned brokerages still sell mutual funds from independent players like AGF Management Ltd., Templeton Management Ltd., Fidelity Investments Canada and CI Financial Corp., among others. But they're less inclined to do so now than in the past; their own funds offer higher profit margins.
A decade ago, the banks' own long-term funds made up about 25 per cent of all new mutual fund sales. In the 12 months that ended this past March, their share soared to 57 per cent.
And the banks' own branches tend to be closed to independent funds. "The actual bank branches, we've been told we cannot go there," said a senior executive at an independent fund company, who spoke under the condition of anonymity out of fear of retribution from the banks. That means a customer who walks into a RBC or TD Bank branch, for example, will be offered only that bank's mutual funds, and may not even know that other – sometimes lower-cost – options exist.
The situation has irked Rob Wessel for years. Mr. Wessel is managing partner of Hamilton Capital, an asset management firm in Toronto, and used to cover Canadian banks as an equity research analyst for National Bank Financial.
"Independent domestic mutual fund companies are at a massive distribution disadvantage to the banks, which explains why so many have sold or partnered with a larger competitor over the past 10 years," he says.
Asked about these concerns, the banks say that less-sophisticated clients with small amounts of money to invest don't need an abundance of options. They also reiterated that their retail brokers, who serve wealthier investors, sell all sorts of funds. Rajiv Silgardo, co-chief executive officer of Bank of Montreal's global asset management arm, said only about 10 per cent his bank's exchange-traded fund sales come from its BMO Nesbitt Burns brokers.
Still, the broader data demonstrate the shift is real. Not only are the banks hiring product experts to create their own "proprietary funds," they are buying whole companies.
Last year, TD Bank bought U.S.-based Epoch Investments for $668-million to expand its equity fund offerings. A few years ago, RBC bought London-based BlueBay Asset Management to add depth to its lineup of fixed-income funds. And Scotiabank's deal for DundeeWealth mopped up one of the more vigorous independent fund companies in Canada.
The banks stress that they have no malicious intent. By expanding their offerings, they say investors are better served because they have more options. And selling their own products simply makes sense because they earn more money on them.
But their growing power should cause regulators to act, some say. Mr. Wessel, for example, is a strong advocate of a rule change that would force bank branches to have open architecture – to carry other companies' funds.
In the early 1990s, U.S. banks became very active in developing proprietary funds, and the situation eventually drew the attention of financial watchdogs.
In 2004, regulators dinged Morgan Stanley for giving its brokers small incentives – such as steak dinners – for pushing their own products above others.
In Canada, the topic is little discussed by regulators.
Across the board, the banks say that they seek to act in their clients' best interests, taking things like an investors' risk tolerance and investment timeline into consideration, as regulations require them to do. But they do not worry about the concentrations of their own funds in customer accounts.
Consider RBC's Private Investment Management product, an account that gives the investment adviser considerable discretion to invest his client's money as he sees fit. Naturally, the bank has guidelines for the brokers – such as limits on just how much weight one specific stock, bond or fund can have in the portfolio. But there aren't explicit rules or limits on how much can be in RBC's proprietary products.
BMO's Mr. Silgardo said his bank separates its fund-creation arm, where he works, from its retail brokerage business, BMO Nesbitt Burns.
The two groups have separate profit-and-loss statements, and "every time we have a product, we have to prove to [Nesbitt Burns] why that product is either unique or the best of its kind," he said.
The banks are easy targets for resentment, of course, because they are so big and so profitable. But they can't always be blamed for their competitive advantages. Sometimes, the odds are simply stacked in their favour.
Since the financial crisis, Canadian regulators have required the country's wealth managers to implement better compliance systems that track the risk profiles of client accounts. The costs are significant. Mr. Agnew at RBC said his bank easily spent $15-million to $20-million just to meet some of the latest standards.
Because the expenses are such a burden, it can be hard for independent firms to shoulder them. The banks, however, have the luxury of huge retail banking arms to pick up any slack.
"Scale matters," said Tim Hockey, TD's head of Canadian retail banking. "When you have these increasing compliance costs … what are you going to spread that over?"
Their size is also an advantage when recruiting talent. Stealing a top investment adviser from another firm is expensive – signing bonuses have topped $1-million in some instances, according to several industry sources.
"We do the math on how much [firms are] throwing around to advisers, and we don't feel that people would make money on that adviser in seven or eight years," Mr. Marsh, the independent, says.
The banks, though, are less likely to balk at the price because they know they have size on their side, and can also cross-sell products like mortgage and chequing accounts to their investing clients. (RBC, though, say the cross-sell opportunities are vastly overstated.)
There are also concerns that the banks' emphasis on proprietary products gives them another leg up in the recruiting game. The more of their own funds they sell, the easier it is to convince a client to stay with the bank, even if his or her broker is leaving to go elsewhere.
If a ScotiaMcLeod broker leaves for Macquarie, for example, it is very easy for the bank to call the client and say he or she might as well stay with the bank because the majority of the client's funds are Scotia products anyway.
In this environment, it is tough for Mr. Marsh and his independent peers to look like attractive options. The Big Six have instilled a fear, whether valid or not, that "unless you're at a bank, you won't survive," he said.
The amount of money lost last year by smaller independent firms that generate most of their revenue from serving retail clients.
The Big Six banks' share of assets invested in Canadian retail
RBC's share of profits made by Canadian retail brokerages last year.
Sources: Royal Bank of Canada; Investment Industry Association of Canada; Investor Economics