Fund supermarkets: New Gutenberg press?
cbs.marketwatch.com
By Dr. Paul B. Farrell, CBS MarketWatch
Last Update: 8:37 PM ET Feb 9, 1999
LOS ANGELES (CBS.MW) -- The online investing revolution reminds me of the unemployment created in post-Medieval era. Shortly after the invention of the Gutenberg printing press, 10,000 monks were out of business! Wall Street's brokers are facing the same challenge as they scramble to deal with online discount brokers and their new tools.
One of the most notable is the now-ubiquitous fund supermarkets, one-stop shopping malls where you can pull together a portfolio of no-load funds from several families and do it all through one online discount broker.
Fund supermarkets have become quite popular in a few short years, cutting huge inroads into Wall Street's revenues, making it cheaper for investors to build and manage their portfolios inexpensively. An important distinction is arising these new one-stop shopping centers, however, creating two distinct types of fund supermarkets fighting for control of this battlefield. And, as you'll see, one wants to give investors new freedoms, while the other wants to keep investors dependent:
The Wall Street establishment:
Morgan Stanley Dean Witter, Merrill Lynch, Paine Webber, Prudential and Salomon Smith Barney.
The new do-it-yourself online brokers
Charles Schwab, DLJ Direct, E-Trade, Ameritrade, Fidelity, Quick & Reilly, Vanguard, Waterhouse and Jack White & Co.
Schwab has been one of the prime movers in the do-it-yourself investor cyberspace revolution. They were one of the earliest discount brokers in the 70s, and in the last decade, Schwab has been the leading pioneer of the Web-based online brokerage. Schwab was the first to put the Wall Street Establishment's feet to the fire. As one of Schwab's officer's put it, "Competition is forcing everyone to bring quality up and prices down."
Sabotaging Wall Street's monopoly
The Wall Street Establishment is still dragging it's feet. The kind of discounting offered by fund supermarkets and online brokers means a loss of revenue that's scaring Wall Street. In fact, when the Web and the Internet came rushing into the marketplace in the 1994-95 era, PaineWebber and other Wall Street firms shut down the early Websites developed by inventive young brokers in their regional branch offices.
The old line firms are so used to their monopolistic cartel controlling the retail brokerage business, they still feel entitled to continue charging investors high fees, in spite of the new "level playing field" created by the information superhighway.
As a result, when you invest with one of the Wall Street establishment, you're running a "handicap race," because many are charging you an extra 3 percent (load, commissions and management fees) for the privilege of doing business with them. Of course, their standard answer is that they are providing valuable research and advice, but in this new electronic age that's a mere rationalization.
The Wall Street establishment has had investors dependent on their superior information for so long, over a century, it's a habit they can't shake easily. They prefer the old pre-Web way of doing business -- with investors totally dependent on their advice.
No cash cow
In reviewing Merrill Lynch's supermarket, Fortune wrote a broad profile that fits the entire Wall Street establishment: "Merrill's striving to create a one-stop shop that untangles a well-to-do client's scrambled financial profile from retirement savings to mortgages, then provides an array of mutual funds, insurance products, trust accounts, and loans to put the picture in order."
"The advice and planning will enable Merrill to keep charging rich prices for its products. ... Merrill isn't courting the masses [the do-it-yourself online investors], it's aiming at a narrow segment, the wealthy and the near-wealthy. The target is 'priority households' with $250,000 to $5 million in liquid assets: families headed by executives, doctors, lawyers, entrepreneurs, all too busy making money to manage it."
"The idea of a financial supermarket - a single company that can fill all of a customer's financial needs: from investing to banking, from borrowing to insurance - is not new," according to Money magazine. "The industry tried and failed to build similar conglomerates in the 1980s. Now Wall Street is embarking on another frenzied round of mergers and expansion," like Citigroup. And as one analyst put it, "This time it'll be different."
However, consumer advocate Barbara Roper, director of investor protection for the Consumer Federation of America offers a word of caution: "There's no question that people are receptive to the idea of one-stop financial shopping, but that's not necessarily in their best interests. If for the sake of convenience, consumers no longer discriminate between the products that are out there and end up spending more than they should, that's not a good thing."
Here's what the near future will look like: By the year 2009, less than a decade from now, the Wall Street Establishment will be either out-of-business (highly unlikely), or they'll clone the major Web discount brokers, and look exactly like Schwab, Fidelity and Jack White.
Forrester Research's conservative estimate of investors going into Web trading is 25 percent: Our estimate is closer to 50 percent, but in either case it's a big enough critical mass to move the market.
Co-dependent
Merrill Lynch, Salomon Smith Barney, and the rest of the establishment are running scared, finally been making counter-offensive moves in the past year. Smith Barney's offering no-load funds (although loading them with an extra 1.5 percent annual fee). Merrill's finally opening up to some limited Web account trading. And Morgan Stanley Dean Witter's Discover and DLJ Direct are clearly moving into the fund supermarket as well as online brokerage business.
Unfortunately, the Wall Street establishment's new supermarkets are part of a concerted plan to increase annual fees - to offset the loss of commission revenues by charging 1.5 to 3 percent annual fees for a service that costs nothing if you go directly to a no-load fund family or work through most discount brokers. And this isn't the only game Wall Street's playing to keep investors dependent.
There are other gimmicks:
1. "Brokers" get new nametags: In the last couple years virtually all Wall Street "brokers" put on new nametags. Now a broker is a "financial advisor" because advertising research showed that the public thinks "brokers" have about as much integrity as used car salesmen.
2. "Loaded no-load funds:" Sure, you can buy no-load funds from Salomon Smith Barney, but Kiplinger's hit the nail on the head, calling this new fund service "loaded no-loads," because they defeat the purpose of a no-load fund. Here's how the game works. If Smith Barney puts an investor in a top index fund like Vanguard's Index 500, which has a low expense ratio of 0.19 percent, and then adds on an annual management fee of 1.5 percent, Smith Barney has in effect increased your expenses 7.5 times over for being in this fund. Vanguard will give you the advice free. As Morningstar president Don Phillips put it, the price is too high, "When you tack on the expenses of the underlying funds, you're talking about giving up a quarter of the return you can expect to earn."
3. Higher commissions: "If paying the lowest possible commissions on stock trades is paramount, don't shop at the supermarkets," says Money magazine. "Deep-discount firms will almost always give you a better deal" In fact, Merrill Lynch made it clear in the Fortune article that, we "will never compete with a Schwab on price." Why? They can't -- without firing a lot of their "brokers."
But never, is a long time, Merrill Lynch. At the most, a decade is all you have. That's about how long it'll take for the do-it-yourself investors to reach such a powerful "critical mass" that they, not Wall Street, will have absolute control the national and global financial markets.
When I explained these trends to a Silicon Valley executive friend, he laughed. His remarks went something like this: "The Wall Street establishment still doesn't get it. The revolution's passing them by. The Web's taken away their historic control over the Main Street investor. Unfortunately, Wall Street now thinks they can use the Web as a way to keep the investor dependent on them. No way. The next generation is a independent do-it-yourself generation, and they're wise to the game, and growing in numbers."
The Wall Street Establishment is like a medieval priest caste, believing that they have some kind of divine right, some superior insight, some special access to the God of The Markets. No wonder the online investing revolution scares the devil out of Wall Street, why they hate do-it-yourself investors, the new breed of investors has no loyalty, isn't dependent on Wall Street, and does not believe in the Myth of Wall Street's Special Wisdom.
Bottom line: Wall Street's brokers are about to become the monks of the new millennium, thanks to the online investing technologies, especially the new fund supermarkets. By the year 2000, over 25 percent of all 65,000,000 mutual fund investors will have online investing accounts. They are emerging as a critical mass that will control the market, transferring power from Wall Street to Main Street where the allegiance is solely to the computer, the Internet, and their own inner spirit.
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