The Cerulli Report Release The Evolving Retail Direct & Discount Brokerage Market: Distributing Through Third-Party Platforms

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1 C e r u l l i The Cerulli Report Release a s s o c i a t e s T h e C e r u l l i R e p o r t This report defines, sizes, and analyzes the direct channel as it exists in today s financial services world. It incorporates advisor, asset manager, and end-investor data and analysis to provide a comprehensive view of the impact of the direct channel on all relevant players. Four proprietary surveys, secondary sources, and 30 executive interviews provide data for this report. Key Findings: Growth in the direct channel outpaced advisory channels growth in the past two years; the former grew at 19% and the latter at 14%. For asset managers, a significant opportunity lies in retail direct third-party platforms. The direct channel is the second largest retail distribution channel, with nearly $3.7 trillion in assets on direct platforms. Among the investing public, ownership of direct accounts is pervasive. 67% of households report owning a direct account. The success of direct firms has relied on their ability to efficiently serve clients with a multi-channel approach, including phone, web, in-person, , and chat. Direct firms aim to keep the client experience similar and seamless regardless of the channel clients prefer. Direct firms are among the fastest growing channels distributing managed accounts programs. Exclusive Data and Analysis: Target Audience Direct firms Asset managers Distributors/broker/dealers This report helps broker/dealers: Size the channel and identify the key players Evaluate the competitive positioning of direct firms within the retail financial market Determine which firms are building direct advice programs Understand why clients invest on direct platforms and profiles of direct clients Release: December 2011 Cerulli Associates Boston Singapore London Proprietary direct channel sizing, and asset projections Profiles of the top firms in the direct channel Product use trends Communication channel analysis Direct account owner profiles Assets for mutual funds, nonproprietary mutual funds, and ETFs on direct platforms Description of levels of advice and guidance This report helps asset managers: Understand the size and strength of retail direct third-party platforms Assess the profitability of this channel relative to others Determine strategies for addressing the direct channel Evaluate the growth of managed accounts via direct channels Report Details 90 exhibits 171 pages Table of contents follows Purchase Includes: Hardcopy NEW: Color softcopy Online access Exhibits in Excel format Analyst access To order: Contact Account Management CAmarketing@cerulli.com Order online Fax form on page 3. Exhibit 2.05: Advisor Channel vs. Direct Channel by Assets Under Management and Growth, ($ billions) Source: Cerulli Associates Assets Under Management Distribution Method Year CAGR Advisor $9,595 $11,227 $12, % Direct $2,598 $3,196 $3, % Attached: Table of contents Exhibit list User examples Sample pages Firm list

2 C e r u l l i The Cerulli Report Release a s s o c i a t e s T h e C e r u l l i R e p o r t USER EXAMPLES Release: December 2011 The following are examples of how this report can be applied to business planning and strategic decision-making: Scenario 1: An asset management firm is performing a channel evaluation in order to align resources more strategically. Its legacy is in the advisory channels, but it is exploring how to expand its reach. The direct platforms have long been an important, low-cost source of assets for them, and they seek more insight so they can identify changes, if any, that they should make to how they approach this channel. The Cerulli Report : The Evolving Retail Direct & Discount Brokerage Market: provides the following answers: How are asset management firms addressing retail direct third-party platforms from a sales perspective? What is the non-proprietary mix of assets flowing through retail direct third-party platforms? What are the trends impacting Cerulli s outlook for this channel? Cerulli Associates Boston Singapore London Scenario 2: A broker/dealer firm is considering how to address investors that don t want or need full-service advice, but yet want to keep their business with the firm. In addition, they want to build a service model that can serve smaller accounts so advisors can focus on higher net worth clients. The Cerulli Report : The Evolving Retail Direct & Discount Brokerage Market: provides answers to the following questions: How prevalent is the direct model among investors? Of investors who hold a direct account, how many consider that their primary account and how many also have a full-service relationship? How are firms enhancing their retail direct servicing offers to remain competitive? Scenario 3: An asset manager is evaluating its role in the managed accounts industry and is seeking insight into the growth areas. The Cerulli Report : Distributing Through Third- Party Platforms provides answers to the following questions: How significant is the direct channel in driving assets through managed accounts? Which managed account programs are most attractive to retail direct investors and why? How are firms targeting retail direct managed account assets? For more information on how to apply this report to your firm s unique needs, please contact our Marketing & Business Development team at , CAmarketing@cerulli.com.

3 C e r u l l i The Cerulli Report Release a s s o c i a t e s T h e C e r u l l i R e p o r t PURCHASE DETAILS Release: December 2011 To order, contact: Marketing & Business Development CAmarketing@cerulli.com Order Online at Fax completed form to Purchase includes: Hardcopy NEW: Color Softcopy Online access (unlimited per firm) Exhibits in Excel format Analyst access Cerulli Associates Boston Singapore London Fax Back Form: f=ïçìäç=äáâé=íç=çêçéê=íüáë=êééçêí k~ãéw cáêãw qáíäé ^ÇÇêÉëëW müçåéw `áíó pí~íé wáé bã~áäw Upon receipt of the faxed form, we will send you an invoice reflecting the fee. Special Feature: To view thumbnails of the contents of this report, please visit our website at Go to Purchase>Thematic Report Subscriptions and click on view next to the report title. Note: These thumbnails are provided to show the layout of select pages in this report. Full scale views of these pages are not available, unless they are highlighted in blue on our website. Cerulli Associates 699 Boylston Street Boston MA Tel: Maxwell Road Singapore Tel: Page 24 Page Betterton Street London WC2H 9BP

4 SAMPLE SECTION from THE CERULLI REPORT: THE EVOLVING RETAIL DIRECT & DISCOUNT BROKERAGE MARKET: DISTRIBUTING THROUGH THIRD-PARTY PLATFORMS

5 This growth was in part due to direct investors being more aggressive investors than their advised counterparts (see Chapter 6). In addition, direct firms likely benefited from households diversifying their assets by opening additional financial accounts after the market downturn. Cerulli s previous research showed that households adopted the idea of diversifying across financial firms in addition to diversifying across asset classes, as they doubted the trustworthiness and solvency of any one provider. EXHIBIT 9: ADVISOR CHANNELS VS. DIRECT CHANNEL ASSETS UNDER MANAGEMENT AND GROWTH, ($ BILLIONS) The direct channel outpaced the growth of advisor channels over the past two years. Assets Under Management Distribution Method Year CAGR Advisor $9,595 $11,227 $12, % Direct $2,598 $3,196 $3, % Source: Cerulli Associates Analyst Note: Direct assets exclude hedge funds distributed directly by hedge fund managers. Sources have been condensed; please see Exhibit 2.02 for a complete list of sources. In addition to being the second-largest channel and among the fastest growth channels, the direct channel boasts some of the largest individual firms. The nearby chart compares B/D platforms, RIA custodial platforms, and direct platforms, showing the largest thirty retail platforms as measured by assets. Individual firms with multiple business lines are separated by the type of platform and may appear more than once on the list. For instance, Schwab appears twice on the list, once for their RIA custodial platform and once for their direct platform. Nine direct platforms make the list of the thirty largest retail platforms. In fact, two direct platforms are larger than both UBS and Schwab s RIA custodial platform, claiming the fourth and fifth rankings overall. The direct channel is highly concentrated, as the largest nine firms listed account for over 90% of overall direct assets. This fact makes the direct channel an appealing distribution target as asset managers may focus their distribution efforts on a small group of firms. The size of direct firms may be surprising to some. While the direct distribution method may be discounted as passé niche of retail distribution, in fact, the direct channel boasts some of the largest platforms in the retail market. 36

6 mutual funds and individual securities. Exchange-traded funds are the third most-used product on direct platforms, but only account for 3% of overall assets. EXHIBIT 11: DIRECT CHANNEL ASSETS BY PRODUCT, 2010 ($ BILLIONS) Mutual funds make up 67% of assets in the direct channel, while individual securities account for 30% of assets. Individual securities, 30% % ETFs, 2% Variable annuities 1% Fixed annuities, 0% Separate accounts, 0% Mutual funds, 67% Source: Cerulli Associates Chart excludes hedge funds distributed directly by hedge fund managers. Sources have been condensed; please see Exhibit 2.02 for a complete list of sources. While mutual funds dominate retail direct platforms, the bulk of mutual fund assets are not addressable to outside managers. Of the $2.4 trillion in mutual fund assets on direct platforms, only $727 billion are invested in non-proprietary mutual funds. However, direct platforms are migrating away from a proprietary fund focus. Some, such as TD Ameritrade, made the decision to only distribute non-proprietary funds in order to maintain a non-biased offering for their clients. Others, such as Schwab and Fidelity, continue to distribute their own products, but offer a best-of-breed select list of third-party managers. Across all direct platforms, the proportion of assets in non-proprietary funds has increased from 25.6% of mutual fund assets in 2008 to 29.8% of mutual fund assets in 2010, amounting to an almost $300 billion increase. Cerulli analysts expect direct platforms to continue to follow the rest of the industry away from proprietary product focus. Particularly as managed accounts continue to grow in the direct channel (see Chapter 5), the proportion of proprietary funds will continue to decline. In managed accounts, direct providers have less pressure to use their own funds because they are compensated via a wrap fee on the clients managed assets and do 38

7 INDEX OF COMPANIES American Century , 137, 138 Bank of America , 147, 148, 149, 150, 155, 164 Bank of America/Merrill Lynch , 96, 148, 149, 155, 164 BlackRock/iShares E*Trade , 14, 23, 26, 27, 28, 43, 49, 50, 52, 55, 70, 76, 85, 86, 97, 102, 143 Edward Jones Edelman Financial Fidelity , 14, 23, 24, 25, 28, 38, 41, 43, 46, 47, 48, 52, 71, 85, 86, 92, , 102, 109, 113, 117, 126, 127, 135, 139, 141, 143, 164 Fisher Investments , 146 FolioFN , 28, 150 Interactive Brokers Hedgeable James Advantage , 138 Janus Lockwood , 136 Meridian MetLife , 47 Morgan Stanley , 164 Morningstar , 49, 71, 109, 110, 136, 142 Mutual Fund Store Personal Capital PIMCO Raymond James Schwab , 14, 21, 23, 26, 27, 28, 36, 38, 43, 44, 45, 48, 52, 55, 76, , 92, 97, 102, 109, 112, 113, 127, 135, 139, 143, 164 Scottrade , 27, 28, 69, 70, 113 T. Rowe Price , 138 TD Ameritrade , 14, 26, 27, 28, 38, 43, 48, 49, 50, 52, 55, 76, 85, 97, 102, , 136, 143, 164 ThinkorSwim TIAA-CREF UBS , 36, 164 U.S. Trust Vanguard , 14, 23, 25, 43, 51, 52, 69, 83, 92, 102, 123, 141, 144 Wachovia Wealthfront Wells Fargo , 147,

8 TABLE OF CONTENTS INDEX OF EXHIBITS REPORT SCOPE METHODOLOGY KEY FINDINGS SECTION I: RETAIL DIRECT MARKET SIZING Overview CHAPTER 1: DEFINING RETAIL DIRECT The Self-Directed Myth Definition of Retail Direct Client Acquisition Compensation Advice Retail Direct Models Mutual Fund Direct Discount Brokerage Firms Retail Direct/RIA Custodial Key Recommendations CHAPTER 2: MARKETSIZING Methodology Marketsizing Key Recommendations CHAPTER 3: FIRM PROFILES Schwab Fidelity TD Ameritrade E*Trade Vanguard Key Recommendations SECTION II: RETAIL DIRECT INVESTOR PROFILES CHAPTER 4: SEGMENTING DIRECT ACCOUNT OWNERS Active Traders vs. Long-Term Investors Primary Relationship vs. Secondary Relationships Direct Client Types Advice Orientation Age Client Segmentation in Practice Key Recommendations

9 CHAPTER 5: SERVICING DIRECT CLIENTS Contact Channels Dedicated Representatives Transition to Guidance and Advice Guidance Financial Planning Managed Accounts Private Client Services RIA Referral Client Acquisition Client Retention Key Recommendations CHAPTER 6: PRODUCTS Mutual Funds Exchange-Traded Funds Annuities Individual Securities Rollovers Retirement Income Banking Key Recommendations SECTION III: RETAIL DIRECT OUTLOOK CHAPTER 7: ASSET MANAGER ADDRESSABILITY Profitability and Quality of Assets Strategies for Addressing Direct Platforms Angering Advisor-Sold Distribution Partners Opportunity Summary Key Recommendations CHAPTER 8: THE FUTURE OF THE RETAIL DIRECT MODEL New Entrants Merrill Edge Case Study Retail Direct Model Assessment Direct vs. Advisory: Competition and Coexistence Projections Key Recommendations GLOSSARY OF TERMS INDEX OF COMPANIES

10 INDEX OF EXHIBITS CHAPTER 1: DEFINING RETAIL DIRECT 1. Advice Orientation by Direct Account Ownership, Direct and Advisor Channel Characteristics, Business Model Comparison Direct vs. Advisor, CHAPTER 2: MARKETSIZING 4. Cerulli Wealth Tiers, Households Investable Assets by Type of Asset, Retail Marketshare by Distribution Method, Retail Distribution Channels by Assets Under Management, Retail Distribution Channels by Assets and Growth, Advisor Channels vs. Direct Channel Assets Under Management and Growth, Top-30 Retail Platforms by Assets Under Management, Direct Channel Assets by Product, Marketshare of Proprietary and Non-Proprietary Funds in Direct Channel, Mutual Fund Assets by Channel, Direct Assets by Product and Growth, Retail Household Investments by Distribution Channel and Product, CHAPTER 3: FIRM PROFILES 16. Firm Profiles: Summary of Services CHAPTER 4: SEGMENTING DIRECT ACCOUNT OWNERS 17. Direct Account Ownership, Active Trader and Long-Term Investor Metrics, Direct Provider as Primary vs. Secondary Provider, Primary Provider of Households Using Direct Provider as Secondary Provider, Advisor-Reported vs. Client-Reported Direct Account Ownership, Direct Client Types, Direct Account Balance by Client Type, Share of Wallet by Client Type, Advice Orientation of Direct Clients by Direct Client Type, Percent of Self-Directed Households by Age Range and Investable Asset Range, Percent of Households Using the Internet to Conduct Business with a Financial Institution by Age Range and Investable Asset Range, Direct Account Ownership by Age Range, Advice Orientation of Direct Clients by Age Range,

11 CHAPTER 5: SERVICING DIRECT CLIENTS 30. Number of Branch Locations by Direct Provider, Communication Channel Advantages and Disadvantages, Average Annual Contact by Type of Contact and Primary Provider Channel, Level of Contact by Direct Client Investable Asset Range, Percent of Direct Clients Using Contact Channels by Investable Asset Range, Primary Direct Clients Desired Amount of Contact by Type of Contact, Levels of Advice and Guidance Services, Primary Direct Clients Description of their Direct Provider, Direct Account Owners Desired Account Features, Total Managed Account Assets by Channel, Q Mutual Fund Advisory Account Ownership by Primary Provider Channel, Desired For Tax Management by Investable Asset Range, Managed Account Assets by Program Type, 2Q Q Estimated Performance of Packaged vs. Open Managed Account Programs, Q Primary Provider of Affluent and High-Net-Worth Households, Business Model Comparison Direct vs. Advisory, Reason for Establishing Direct Account by Investable Asset Range, Importance of Cost in Establishing Direct Account, Client Satisfaction by Primary Provider Channel, Client Dissatisfaction by Primary Provider Channel, Level of Satisfaction by Direct Firm, CHAPTER 6: PRODUCTS 51. Risk Level by Client Type, Risk Level, Mutual Fund Ownership by Direct Client Type, ETF Ownership by Direct Client Type, Reasons Household Purchased ETF by Investable Asset Range, Annuity Ownership by Direct Client Type, Primary Direct Clients Opinion of Annuities, Variable and Fixed Annuity Total Sales, Direct Account Owners Reason for Annuity Purchase, Individual Stock and Bond Ownership by Direct Client Type, Percent of U.S. Households Investable Assets in Individual Securities by Age Range, Percent of Households with Formal Retirement Income Plan by Age Range, Rollover Sizing,

12 64. Desired Features of Retirement Income Plans, Top-of-Mind Banking Providers by Provider, CHAPTER 7: ASSET MANAGER ADDRESSABILITY 66. Industry Executives View of Direct Channel, Retail Channel Rankings: Service Costs, Retail Channel Rankings: Profitability, Retail Channel Rankings: Gross Sales, Industry Executives Views of Affecting Direct Channel Sales, Levels of Engagement in Direct Channel Sales, Most Important Elements in Developing Relationships with Professional Buyers, Number of Appearances per Select List per Asset Manager, Asset Managers by Appearances on Direct Platform Select Lists, 3Q Consumer Advertising: Primary Focus, Opportunity Index: Direct Platforms, CHAPTER 8: THE FUTURE OF THE RETAIL DIRECT MODEL 77. Banking and Brokerage Profile: Bank of America/Merrill Lynch Wealth Tier Analysis, Primary Provider by Investable Asset Range, Advice Orientation, Direct Managed Account Asset Projections, Direct Channel Asset Projections,

13 REPORT SCOPE Retail Direct & Discount Brokerage Market: Emerging Opportunities in an Evolving Marketplace, the most recent study in the Cerulli Report Series, examines the state of the retail direct channel. This report defines the direct distribution model as it exists in today s retail financial services landscape, outlines the products and services delivered by direct firms, offers a marketsizing of the direct channel, and analyzes opportunities for distributors and product manufacturers. Beneficiaries of this Report Retail direct firms wishing to better understand their competitors and evaluate their offerings relative to the overall trends in the direct channel as well as how the direct channel compares, contrasts, and overlaps with other retail channels. Asset managers and other product manufacturers wishing to evaluate the direct distribution opportunity and develop strategies for addressing direct firms by understanding their services, clients, and product offerings. Other retail distributors- wishing to better understand the retail direct channel including the size, types of clients, and types of services offered, to evaluate the feasibility of launching a direct platform, or to understand the competition presented by direct firms. 10

14 METHODOLOGY The following analysis of the state of the retail direct channel relies on a combination of quantitative and qualitative analyses conducted by Cerulli Associates. Our research draws on our own market insight and proprietary data, as well as our analysis of third-party information sources. Federal Reserve The Federal Reserve s Survey of Consumer Finances serves as the foundation for Cerulli s marketsizing of the retail financial marketplace. Cerulli analysts employ this data to project the division of wealth among products as well as between households of differing wealth tiers and ages. Cerulli Direct Survey Cerulli conducted a survey of retail direct firms, asking the firms to report their direct platform assets to Cerulli. Responses were gathered in between 2Q2011 and 4Q2011. This was the first iteration of the survey which Cerulli intends to repeat annually going forward. Cerulli-Phoenix Research Partnership Phoenix data in this report comes from Phoenix s Global Wealth Monitor which is the largest affluent study in the United States, surveying 7,800 households throughout the year. The target market for this survey is affluent and near-affluent households with more than $50,000 in annual income or more than $250,000 in investable assets. While less wealthy households are included for comparison purposes, the respondent base is wealthier and slightly younger than the American population overall. Cerulli Advisor Survey A proprietary survey of the population of financial advisors in the U.S. serves as the data source for advisor comparisons shown throughout the report. In this annual research survey, CA asks financial advisors from all channels and of all practice types for their opinions on a range of factors, including asset allocation, security selection, and client relationships. 11

15 Cerulli Asset Management Survey As part of ongoing research, Cerulli conducts an annual survey of U.S. asset managers. This survey provides high level overviews of asset management business organizations. Qualitative Interviews As part of our ongoing research initiatives, CA analysts regularly interview key executives at distributors, asset management firms, as well as other industry observers. For the purposes of this report, CA analysts conducted qualitative conversations with executives at the leading direct firms, as well as many smaller direct firms. In addition, CA analysts interviewed asset managers for their opinions of the direct market. All interviews were conducted on a background basis and without attribution. The conversations reinforced the findings of our survey work and provided additional valuable insights reflected in this study. As with all Cerulli Reports TM, additional information in this report was obtained from third-party public and non-confidential sources that Cerulli Associates believes to be reliable, and we have made every reasonable attempt to verify it; however, CA does not guarantee its accuracy or completeness. 12