Morgan Stanley Credits Market for Record Rise in Fee-Based Assets
Showing just how sweet the stock market was for retail brokerage firms last year, 55% of the growth in fee-based assets at Morgan Stanley’s wealth management unit in 2017 came from market gains. The number contrasts with 34% in 2016.
The disclosure, made in the wirehouse’s annual 10-K regulatory filing on Tuesday, also could add evidence to the low “organic” growth of new money that existing and new customers are giving large brokerage firms to manage.
Merrill Lynch, which has embedded penalties and awards for new assets in its 2018 compensation plan for brokers, credited about 51% of gains in fee-based asset growth last year to the stock boom. The S&P 500 rose 19.4% in 2017, and brokerage firms have been increasingly charging clients a percentage of their account assets rather than transactional commission charges.
The numbers, however, indicate the double-edged sword of fee-based revenue programs, particularly for firms where net new assets are under pressure as customers test passively managed index funds and robo-advisory firms. In years when markets fall, so do fees associated with the value of customer accounts. At big brokerage firms, fee-based accounts have grown to one-third or more of client assets. They were 44% at Morgan Stanley at yearend, reflecting Chief Executive James Gorman’s longstanding push for asset-based revenue.
“It’s becoming the more popular way for advisors to interact with clients, but at a certain point the actual growth is going to be heavily influenced by the growth in the markets,” said Tom O’Shea, director of managed accounts at Boston-based consulting firm Cerulli Associates. “When it becomes the way you do business, you see the effects of the market more dramatically.”
Client assets in fee accounts at Morgan Stanley’s wealth management division hit a record $1.045 trillion last year, up from $877 billion at the end of 2016. However, new money flowing into fee-based accounts dropped to $209 billion last year from $250 billion in 2016.
Net “flows,” which include money leaving fee-based accounts, rose 55% during the year to a record $75.4 billion as fewer customers exited than in 2016.
Paradoxically, if stocks continue to spook retail investors, as they did in early February, retail investors may provide a short-term boost to commission-based accounts.
“When you have a market correction, there’s a lot of trading in commission-based accounts because investors do what they’re not supposed to,” O’Shea said.
In another indicator of Morgan Stanley’s wealth management performance, the company said in its filing that securities-based general purpose loans made to wealth customers soared 14% to $41.2 billion as of yearend 2017. The so-called securities-backed loans, collateralized by client portfolios, differ from margin loans that are used solely for making investments.
The broker-dealer has been encouraging its 15,700 brokers to sell credit products that have long been promoted to wealthy clients by rivals such as Merrill and Wells Fargo Advisors that are owned by large commercial bank companies. However the pace of growth in SBLs slowed from 26% in 2016, when the company was fined $1 million by the state of Massachusetts for aggressively promoting the lines of credit through incentives that included higher expense accounts for successful brokers.
A spokeswoman said the year-over-year decrease was not related to “sales concerns.”
“As a percentage basis, it’s slowing,” Morgan Stanley Chief Financial Officer Jon Pruzan said in January, referring to loans drawn down from the SBL lines. But he defended the product, noting that advisors still have room for “incremental growth.”
While brokers continue to focus on building assets, loans and other “liability” products on Morgan Stanley’s books at the end of 2017 were valued at $80 billion, up 10% from 12 months earlier. Loans help glue clients to a firm, even when their broker leaves, Morgan Stanley Chief Execut James Gorman said last year.
Client and broker retention have become an increasingly important strategy for Morgan Stanley, which last summer curtailed expensive recruiting efforts and in November exited the Protocol for Broker Recruiting. That so-called Prexit gives it ammunition to sue departing brokers who attempt to solicit their former clients to join their new firms, litigation that has been partially successful.
On another front, Morgan Stanley is benefitting from the expiration of the “forgivable” retention loans it paid to brokers it absorbed from its purchase of Smith Barney acquisition between 2009 and 2013.
Employee retention and recruiting loans on the company’s balance sheet fell to $4.185 billion at the end of 2017 from $4.804 billion a year earlier, according to the 10-K filing. The run-off in Smith Barney retention loans could add 100 basis points to Morgan Stanley’s profit margin once all the loans have amortized by next year, Morgan Stanley executives have said.
In another earnings development, the company lowered its previously reported 2017 profit by $43 million to reflect adjustments related to the new tax law and related executive compensation changes, the filing said.