In this issue, we continue our exploration of the Future of Finance with two articles discussing the future of the investment industry in Canada. We look at the evolving relationship with advisors and clients — and the way technology is transforming the space. We also look at ways that Canada’s independent dealers could adapt and change to succeed in shifting the Canadian investment landscape.

For far too long, markets and other external factors have provided timely cover for Canada’s independent dealers in explaining their inability to compete effectively with the vertically integrated bank behemoths in wealth management. Rocky equity markets may hamper retail investor willingness and small equity financings, but today there seems to be a deer-in-the-headlights mentality among independents—a tendency to wait until markets skate everyone onside, short memories prevail, and all is good again.

It’s time to stop confusing brains with a bull market.

Two earlier articles in The Analyst by Ian Russell (March) and Nick Thadaney (June) accurately laid out the many challenges facing Canada’s small dealers, who are clearly at a material disadvantage. In my view, however, the independent model in Canada is what’s broken, not the environment. Ask any CEO what they would do differently if they could start over and you’ll get a long list. The problem, of course, is that starting over is nearly impossible when you’re atop an established firm with embedded defenders of the status quo: “We tried that once.” “It won’t work here.” Or the change discussion never gets started: “What difference would it make?” “You can’t get there from here.”

While that may be true, something must change because current independent models are simply not working effectively. The largest independents are hanging in, but they struggle to strike the right balance between building capital markets and equally strong retail distribution. Smaller dealers, on the other hand, have neither the capital nor the scale to build sustainable positions in either segment. The relationship between the largest and the smallest is akin to tall trees blocking sunlight from smaller ones. Eventually the smaller ones die off, which is what we’ve been witnessing in the Canadian investment space.

Redefining independence

Central to the weakness in many current independent models is the desire to mimic the traditional structure of an old-school dealer in order to compete with much larger bank-enabled foes. The results of the head-to-head competition are not pretty, and therein lies the lesson. Any independent’s value proposition must be about what makes that firm unique and viable, rather than its areas of competitive inferiority. One example is culture, naturally a vulnerability of large, impersonal institutions, and the differentiating power of which has been overlooked by independents.

The key to an effective business model lies in defining independent as something more than simply “not owned by a bank.” The independent model must be different and offer an attractive alternative to, rather than a lesser version of, the traditional model. “Independent” must come to mean unique, different, and free of large institutional bureaucracy. If you’re small, you’d better be fast, because small and slow is a recipe for extinction.

The last decade has seen an explosion of U.S. advisors striking out on their own, spawning the Registered Investment Advisor (“RIA”) phenomenon. The expansion of RIAs, true owner-operators with mostly discretionary, fee-based businesses, has reached an inflection point. RIAs are now being gathered up under umbrella companies in which scaled custody and clearing, product development, and technology platforms can be provided more cost effectively. Add some national branding, and you’ve addressed the key items that most Canadian independents lack.

“The independent model must be different and offer an attractive alternative to, rather than a lesser version of, the traditional model. ‘Independent’ must come to mean unique, different, and free of large institutional bureaucracy.”

What needs to change?

The opportunity exists in Canada to jump ahead, past any lengthy evolution, to a sustainable new model for the future. No black box or rocket science required, just a blank sheet of paper and a healthy dose of reality. There are too many sub-scale dealers today trying to do it all, and doing very little of it well.

The independent dealer community would be far more competitive and viable through open strategic alliances in a marketplace of distribution and manufacturing expertise.

A scalable marketplace of specialty shops can compete more effectively with supermarkets. The result would be manufacturers and distributors exploring endless combinations for greater market penetration, a “1+1=3” value proposition. Open architecture and portability are long overdue in Canadian financial services.

A dealer model for the future begins with recognizing that most independents should choose either distribution or manufacturing and stop trying to be both. It’s hard enough with a single business. If the focus is wealth management, then what’s needed is a system of highly trained, well-equipped advisors capable of delivering a broad range of solutions. And if the focus is on manufacturing those solutions, then innovate, create, and perform all day for the broadest possible distribution network.

Finally, any successful independent wealth model must be investment advisor (“IA”)– centric, featuring ownership at every level, from the IA’s practice, to the local branch, to the firm itself. Treat the advisor as the centrepiece of the model, and you will attract the best. Instead, most are currently treated as mercenary asset gatherers, lured by big up-front cheques. No one likes this culture of buying advisors, yet independents have done nothing to change the game by changing their value propositions. Instead, the game has been ceded to those who can write the biggest cheques, and clearly that doesn’t favour independents.

A strong independent dealer community is critical for the industry, and specifically for investors. If independents have the courage to change their value propositions from the foundation up, the result will be loyal teams who are personally invested in the future of the firms—their firms—that will thrive within strong cultures that result. That is the very same culture that built Bay Street to begin with, and which is—sadly—rapidly fading.