So let’s start with a fun question. Going into this morning, how much were the S&P and Dow (I know, I know, no one uses it) down for the year? Answer at the bottom.
So, now to address my earlier point about the retail business being fine. As the Hertz commercial says: "nottttt exacttttly". In fact, Retail business may well end up a decent LOSER for a lot of firms.
A really crude 3 minute read of the retail business as it stands today looks as follows (these numbers are made up, but the concept holds):
Profit: Take the assets for some random boutique firm to make the numbers easy: Let’s call it $1b. Let’s say their average fee is 1.2% per annum. So each year they will rake in $12m from their retail arm–assuming it's all fee-based–or $1m a month.
They probably pay their brokers half of that let’s say, so now they have $500k per month to cover their expenses. This includes all non-producing administrative costs, which are mostly fixed salary if they are unlicensed. This includes the office rents, also fixed. Non-producing rookie brokers, unless you fire them, are often on salary as well. And if you do fire them, their 5 or 6 clients may well leave you, which will partially offset your savings there. Costs also include compliance costs, fixed. In short, while some things can be cut back on (supplies, perhaps educational programs, etc), many of the costs to run a retail arm are FIXED.
Now here is the beautiful part, of that $500k per month that doesn't get paid out, maybe $300k goes out the window for fixed costs, and another 100k in incentive costs for the managers and licensed administrators leaving $100k in profit for 20% profit margin.
For bigger firms, there are much bigger fixed costs that boutique firms don't have (1-800 numbers and the people who staff them, an ongoing technology bill for service), etc. But I digress. We have $100k in profit a month for our mythical boutique firm with an annuitized book. Now let’s assume the firm's assets under management drop by 10%. Instead of $1m a month in gross income, $900k is coming in monthly. $450k still goes to the brokers, but instead of 100k profit, its now only $50k profit. Maybe some of the bonuses get scaled back for management, maybe some people get fired, maybe that awards trip is to Des Moines next year instead of Honolulu, but still, a 10% drop is in many cases a 30-40% drop in profits, if not an outright loss for bigger firms running on thin profit margins.
In the old days, if the market fell, that wasn't great, but wasn't horrible. If anything the extra volatility and volume meant more orders processed on a per share basis, more people jammed into high commission annuities, and out of b-shares (another commission hit) into CD's or such. Now, with firms mostly preaching annualized recurring profits on a planning basis (not a bad strategy by the way), the firms will be the big losers. They made their bed, and they will sleep in it more than ever. Sure the Eddie Jones's of the world still use largely A-Shares, and no firm is fee-basis only, but the trend has been strongly that way the last 5-10 years.
Some producers might see a slightly smaller paycheck, but shareholders might see a much smaller dividend, and for the firms out there that are counting their retail arm to bail them out of the subprime debacle, a big drop in the markets is not so great.
Now what's the silver lining? That's right: the markets aren't all that bad... yet.
Some huge retail bond funds have made out like bandits (PTTAX on course for 14% for a bond fund, after 11% last year!!!), and the S&P is only down 9.5% as of close on Friday, with the Dow down 7%ish, but factor in today and the recent rally and things aren't that bad, not as good as the 5% growth that the planners probably budget in, but not horrible.