Schwab, Merrill Plans Blur Industry’s Lines
On Oct. 15, 1997, 80 senior managers of San Francisco-based discount brokerage Charles Schwab Corp. gathered at the southern end of the Golden Gate Bridge. Each was handed a gold-trimmed navy blue jacket with three words across the back: “Crossing the Chasm.” With Schwab co-Chief Executive David Pottruck at the point, they proceeded to walk across the bridge.
The symbolism was not lost on the group: In the days leading up to the crossing, the company itself had taken a great leap of faith, adopting a bold--many called it high-risk--plan to become a full-fledged Internet brokerage by offering all Schwab customers the ability to trade stocks online for just $29.95.
Many feared the move would cannibalize, even destroy, the discount broker’s traditional and lucrative businesses of catering one-on-one to do-it-yourself investors and to independent investment advisors who serve the let-someone-else-do-it class of investor.
It had just the opposite effect. The company, by leveraging both the power of the Internet and its network of 340 brick-and-mortar customer centers, has brought in client assets faster than any other discount or full-service brokerage in America.
So much so that Schwab, with one-fourth the work force and one-tenth the revenue of full-service brokerage giant Merrill Lynch & Co., has a larger stock market capitalization than Merrill.
Starting Wednesday, however, Merrill takes its own leap of faith, crossing the same bridge that Schwab did two years ago. With the launch of Merrill Lynch Direct, the nation’s largest full-service brokerage will finally allow customers to trade stocks online, without the assistance of one of the company’s brokers.
The price: $29.95 a trade--the same price that Schwab charges its retail clients for basic trades.
The much-anticipated roll-out of Merrill’s Internet service comes just six months after the firm launched another new program, Unlimited Advantage, which does away with traditional commission-based advice and replaces it with an asset-based-fee program.
For a maximum of 1% of assets a year (with a minimum annual charge of $1,500), clients can make as many stock trades as they want while still receiving advice from their Merrill broker--or, as the firm calls them, “financial consultants.”
That program, too, was targeted at Schwab, analysts say--specifically by pitting Merrill’s 18,000-plus financial consultants against the 5,600 independent registered investment advisors (RIAs) who maintain their clients’ assets at, and trade through, Schwab.
“When I listen to Merrill talk and think about where it’s going with this, my first impression is that this is Ali-Frazier,” says James Punishill, an analyst with Forrester Research in Cambridge, Mass. “This is going to be the ‘Thrilla in Manila.’ This is going to be a huge battle for the customer.”
The Schwab-Merrill war is ground zero of Wall Street’s new competitive reality: The lines between full-service and discount brokerages are rapidly blurring.
With a record number of Americans invested in the stock market, and many people’s financial assets dramatically swelled by the 9-year-old bull market, the demand for both basic brokerage services and for financial advice has never been greater.
What many Americans want foremost, however, is the ability to choose brokerage and advice services that fit their needs--and pocketbooks.
For the full-service firms, such as Morgan Stanley Dean Witter and American Express, that has led to initiatives such as Merrill’s new accounts--more flexible brokerage and advice packages that appeal to baby boomers, the largest demographic of investors and a group whose assets are growing rapidly.
Schwab, whose average investor is 47, hasn’t had much difficulty wooing this group. Merrill, whose average investor is the early 50s, has, analysts say.
But with the offensives launched by Merrill and other traditional full-service firms, as well as increasing competition for new accounts from cut-rate online brokerages, Schwab now faces attacks from both sides.
“Schwab’s extraordinary success has changed the rules of engagement in the retail brokerage arena,” says Sanford Bernstein brokerage analyst Steve Galbraith in New York. “As the company has dominated the asset-gathering game, both high-end and low-end brokers are now gunning for Schwab.”
As Schwab’s younger investors become wealthier (the average Schwab customer now has $94,000 in his or her account, versus $400,000 for Merrill customers), they are becoming vastly more appealing targets to traditional brokerages.
Until a few years ago, Schwab was little more than an annoyance to Merrill and other Wall Street titans. But that was before Schwab began pulling in boatloads of assets as it catered both to the independent investor and to investment advisors who used Schwab as a platform for managing clients’ assets.
Though Merrill’s assets of $1.5 trillion still dwarf Schwab’s $600 billion, Schwab’s assets soared 39% in 1998 while Merrill’s rose 17%. In the first three quarters of this year, Schwab pulled in $74 billion in net new customer assets, three times more than Merrill, a Goldman Sachs report estimates.
But Schwab has begun feeling some effects of increased competition. John Koller, analyst at Value Line Investment Survey in New York, points out that “the total of new accounts opened this year [at Schwab] will likely approximate last year’s, despite advertising spending that through the first nine months is already higher than all of last year.”
(Schwab officials shrug that off, noting that the battle is not for the total number of accounts, but for assets.)
To be sure, few analysts believe that Merrill, Morgan Stanley and other full-service firms will easily free themselves from their traditional commission-based brokerage models.
“Merrill and the other firms have announced products and services that tend to indicate that they’re changing,” notes Nicholas Kaiser, manager of the Sextant Growth fund, which recently held about 25% of its assets in Schwab stock. “But tigers have a hard time changing their stripes.”
Amar Mehta, who covers electronic financial services for CIBC World Markets in New York, believes that the full-service brokers, at least in the near term, will find themselves “focused more on internal problems, rather than attracting the next generation of customers.”
Indeed, the transition to fee-based services is expected to be tough for many brokers, some analysts say, as cheap commissions could slash their often-generous incomes, at least initially. And how willing and able many brokers are to provide clients with more general financial help, as opposed to simply pitching products--and for potentially less money--remains to be seen.
Still, “Schwab has to fear what Merrill is doing,” says Geoff Bobroff, an investment management industry consultant in East Greenwich, R.I. “The challenging question is: Where does [Schwab’s] future growth come from?”
Schwab officials don’t believe it will be found at the lower end of the online brokerage industry. “We do not look at E-Trade or Ameritrade as direct competitors,” says Schwab chief strategy officer Daniel Leemon.
Instead, Schwab is setting its sights up the food chain. Some would argue it has no choice.
For starters, households with $1 million to $5 million in net worth are growing faster than all others in percentage terms.
And because trade price is no longer the distinguishing factor between full-service and discount brokers, they all must compete on the quality and breadth of the services they offer.
The challenge for Schwab: Many high-net-worth investors have historically favored traditional stock brokers for one-on-one advice.
Schwab’s brokerage office staffers, by contrast, have been limited in the advice they can directly give to clients.
Right now, investors can get basic recommendations on how to allocate their assets and on individual mutual funds through Schwab’s offices. Schwab also makes available stock research from firms such as Credit Suisse First Boston.
Recently, Schwab also began offering investors “report cards” on specific stocks and funds to help them assess their portfolios.
For more specific advice, Schwab refers investors to financial planners through AdvisorSource, which consists of 425 financial advisors culled from Schwab’s larger network of independent RIAs.
“The key word is ‘independent,’ ” says Schwab Vice Chairman John Coghlan, who heads the firm’s institutional business with independent advisors. “There’s not an association or affiliation with a particular firm or, especially, the products of that firm.”
But with full-service brokerages’ new competitive onslaught, Schwab is launching its own direct-advice service as well.
Starting early next year, Schwab-employed investment specialists will “evaluate” a client’s portfolio, assessing how the portfolio is performing against relevant benchmarks, making asset allocation recommendations and even offering guidance on the specific funds and stocks in the client’s portfolio, whether the assets are held at Schwab or not.
The cost: an as-yet-undetermined fee for each evaluation session.
Company officials envision eventually having 2,000 of these specialists in offices nationwide, many of them current employees.
But the move raises two major risks for Schwab. One is the same problem all advice givers face: accountability for specific investment recommendations. Schwab personnel haven’t faced that before on this level.
Second, some analysts see Schwab’s new initiatives, such as the portfolio-evaluation program, as competing with the financial advisors who work through Schwab--and whose client assets account for 30% of Schwab’s total.
Coghlan denies that “there’s any [competition] at all” between what Schwab is doing on its retail side and its work with independent advisors. He said that different types of investors will seek the custom-tailored advice provided by an independent financial advisor versus the advice Schwab plans to give in its centers.
But Coral Gables, Fla.-based financial planner Harold Evensky, who uses Schwab for back-office services, says it’s “disingenuous” for Schwab to say that it doesn’t compete against smaller advisors.
Right now, Schwab doesn’t have to worry about driving most financial advisors away because many prefer Schwab to the alternatives, Evensky says.
But if a favorable alternative arises--for instance, if a consortium of companies were to create its own back-office service, or if a software company found a way to do that entirely online--that could change, Evensky says. “It seems obvious that that’s coming in the not-too-distant future.”
Jeff Van Harte, manager of the Transamerica Premier Equity fund, which has about 9% of its assets in Schwab stock, acknowledges the challenges the company faces. But, he says, investors shouldn’t underestimate Schwab’s management or its ability to constantly reinvent the company.
“I think it will be very, very difficult for anybody to duplicate what Charles Schwab has done for [the next] 10 years,” he said.
Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
More Investors Trade via the Net . . .
Percentage of investors who use the Internet to trade:
1999: 18%
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. . . but Many Who Don’t Say They Won’t Soon
How investors who don’t have online accounts answered the question: How likely is it that you will start using the Internet to trade in the next 12 months?
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Source: Securities Industry Assn. survey
What Investors Want From Brokers: More, Not Less
More than ever before, individual investors have the ability to make their own financial decisions. Yet a new survey suggests that investors want more help, not less, in managing their money--and that most people who use brokers generally like the advice they get and believe the fees they pay are fair. Key findings of the Securities Industry Assn.’s 1999 investor survey:
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Note: Survey of 1,507 individual investors, 59% of whom have at least one account with a brokerage. Survey was performed by Yankelovich Partners between August and October.
Source: Securities Industry Assn.
