Retail Financial Business, a Hedge? Not Exactly

By TheUnrepentantGunner

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.

Comments

[Stupid Equity Guy]

Gunner...

I laughed when I read this... your comments on the DOW... my TA team was babbling about something or the other index the other week... when I decided to intentionally annoy them by asking what the DOW did...

They got puffy and said Blah Blah Blah about real indexes... I then lean forward and commented that well...

It's only a question from the Fucking Portfolio Manager and WHAT THE FUCK WAS THEIR ANSWER again?...

then all kinds of babbling erupted again...

What's it like in your shop?

~Cranky Old Stupid Equity Guy

(when I am bored and want to watch my analyst jump...)

[Stupid Equity Guy]

oh and great break down on the retail side of things... this market has not started to hit main street yet... I had my family over for Easter, and pinged all of my nephews about what its like in the real world.

The pain is only felt on WS so far... They knew we were freaking out but outside of typical winter slow downs, nothing surprising. In fact, the most surprising thing was how many of them I had to suggest to not buy property right now. Whole damned family thought it was time to rush into the market and take down spare homes...

Makes me almost wonder if its Just US...

~Stupid Equity Guy

great piece... please keep sharing your thoughts...

[TheUnrepentantGunner]

That is excellent EquityGuy.

No one knows here what the dow was at for the year. Most people guessed more than 10% down. They were all wrong of course.

Sounds like you're not the only one with family convinced that this is the perfect time to buy real estate as well...

[Stupid Equity Guy]

Gunner,

You will like this... I have started to only make comment's about the market in Dow points to annoy the guy's... Their PM is on a Dow only diet for market movement comments... lets see how long they can take it... ;-)

So what kind of ammo do you shoot into the market? Equity? Bonds? Exotic's? liquid leverage?

~Stupid Equity Guy

[1-2]

Well, since the rebalance it should be renamed the Dow Jones Banking Average--but that's just me.

Amazingly they picked the right banks to add to the index!

Keep up the comments SEG.

1-2

[TheUnrepentantGunner]

I'd be a fool to acknowledge who I exactly deal with.... and easily exposed. But 1-2 can verify that the conversations you have with your juniors are about the same that goes on with my desk. For that matter so can 3-4 other regulars here.

[Stupid Equity Guy]

Gunner,

Not trying to get you to unmask... Please keep the lone ranger shades on... Was just wondering about the type of ammo you have an endless supply of...

anyone notice that the size of the Lehman put action today? any chance we can start a thread about the Big Sisters and which one gets taken out behind the wood shed next?

~Stupid Equity Guy

[Stupid Equity Guy]

http://bigpicture.typepad.com/photos/uncategorized/2008/03/28/market_madness.gif

I love Berry's chart...