IDA Wealth Watch IN THIS ISSUE... INVESTMENT DEALERS ASSOCIATION OF CANADA

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1 IDA Wealth Watch JULY 25 INVESTMENT DEALERS ASSOCIATION OF CANADA IN THIS ISSUE... Recent developments south of the border pertaining to the discount brokerage industry have raised questions as to what is the current state of affairs for Canada s own discount brokerage firms. This edition of the IDA Wealth Watch looks at a sampling of Canada s discount brokerages and analyzes the group s performance over the last couple years in order to assess the financial health of this sector. To shed further light, comparisons are also made to a sample of full-service retail dealers.

2 Methodology Our study consists of two groups of sampled firms. The first group is comprised solely of nine Canadian discount brokerage firms. The nine firms cover a wide cross-section of the discount brokerage industry and include some bank-owned discounters, discounters with foreign based parents, and several independents. Collectively, these firms manage client assets of approximately $36 billion which represent close to an estimated one-third of total client assets held within Canada s discount brokerage industry. $ Billions Aggregated Client Assets Under Management Sampled Firms $28.9 $43.2 $33.5 $52. $35.8 $57.1 Full-Service Firms For comparative purposes, a second sample of firms was also constructed. This sample consisted of nine full-service retail dealers. All the dealers in this sample were independents, not affiliated with any Canadian bank 1 and had no discount operation of their own. Each of the nine firms had client assets ranging between $3 billion to $1 billion Client Accounts 24 Q1 25 An analysis was then done on the two samples comparing the relative performance of each. Client Assets Both groups of sampled firms have done a good job at attracting client assets. Over the past five quarters, the sampled group of discount firms has collectively grown client assets by a respectable 24%, reaching $35.8 billion as at the end of the first quarter of this year. Our sampled full-service firms did somewhat better during the period, growing assets by 32%. Both groups outperformed the 17% growth experienced by the TSX during the same time frame. This likely implies that a considerable portion of asset growth at both groups of sampled firms came from the gathering of new assets as opposed to the mere market appreciation of the existing asset base. Bank-owned full service dealers were excluded from this sample because their much larger sizes were believed to make direct comparisons between the two samples less meaningful. Not surprising, accounts held at discount brokerages, on average, are significantly smaller than those held with full-service firms. This disparity has also increased over the last few years as the average size of the full service account has increased whereas discount brokerage accounts have remained relatively flat. A possible explanation, and concern, for discount brokers may be that some of their clients may migrate out to the full-service platform once their accounts reach a certain threshold. After a certain level of wealth is amassed, discount investors may feel more inclined to seek the advice of a professional to preserve or further grow this wealth. Additionally, the higher costs associated with maintaining a full service account may be felt to be more justified when the account is of a sufficient size. A second explanation for the smaller average account size could be that discount brokerages are only succeeding in attracting the small do-it-yourself investor. These investors perhaps either feel confident in their own investing ability or do not believe their accounts would attract a sufficient level of interest or service from a full-service advisor. IDA WEALTH WATCH - July 25 2

3 12 Average Account Size mechanics of bond pricing makes it difficult for similar levels of savings (if any) to be realized on bond transactions. $ THOUSANDS Full Service Firms The asset mix in client accounts also significantly differs between full-service and discount firms. Discount accounts contain considerably more equities and far fewer bonds than their fullservice counterparts. The low level of bonds held at discount brokerages is likely the result of two factors; the limited quantity of fixed-income products on their shelves, and the perceived complexities investors have of fixed-income trading. Firstly, though most discount brokers provide fixed-income product offerings to their clients, the offerings tend to be limited to a few liquid issues. Secondly, the perceived complexities of fixed-income products may also propel investors to the guidance of a full-service financial advisor when transacting in these products. Though most do-it-yourself investors may understand the basics of stock investing, and feel comfortable in placing stock trades, we are not so sure that the same holds true for bond investing. Not fully understanding bond fundamentals such as accrued interest, yield, and call features for example may be a deterrent to bond investing for do-it-yourself investors. 3 4 Another notable difference in the asset mix relates to the level of cash clients hold. Investors at fullservice dealers are more fully invested than those at a discounter. This perhaps reflects the longerterm investment approach financial advisors instill in their clients whereas discount investors, who are generally perceived to be more active, may tend to hold more liquid positions as they await their next buying opportunity. The higher cash positions could however also indicate greater market uncertainty in the minds of discount investors. Bonds 9.9% Mutual Funds 19.8% 24 Asset Mix Cash & Equivalents 1.7% Other 1% Equities 58.6% 24 Asset Mix Full-Service Firms Mutual Funds 21.7% Cash & Equivalents 6.6% Bonds 27.7% Other 1% Equities 43.5% Additionally, though the cost savings of executing a stock trade through a discount account as opposed to a full-service account are very apparent, the IDA WEALTH WATCH - July 25 3

4 Commission Revenues Trading activity at discount brokers has fallen drastically since the peak level achieved in 2. However, 24 marked the third year of consecutive trading activity increase, with nearly 17 million trades transacted, helped in part by a strong RRSP season in 24. Number of Trades inmillions Number of Trades in Millions Annual Trading Activity at Online/Discount Brokers Quarterly Trading Activity at Online/Discount Brokers 99 1 The increased trading volumes have helped spur commission revenues at the discounters. Our sampled discounters have seen commission revenues collectively increase from $162 million in 22 to $21 million in 24, a 3% jump. However, commission revenue at our sampled fullservice firms fared considerably better, increasing 6% $ Millions Aggregated Commission Revenues Sampled Firms CAGR $582 : 13.9 % Full-Service Firms: 26.6 % $162 $363 2 $193 $469 3 $21 4 Full-Service Firms Composition of Commission Revenues The composition of commission revenues also differs between our sampled discount and fullservice firms. Not surprisingly, commissions from equity trades account for the lion s share of commission revenues for discounters whereas the full-service firms are less dependent on equity commissions. Both samples however do show a reduction in the amount of commission revenues generated from foreign securities in 24. This reflects Canadian investor increased appetite for domestic holdings, given a healthy Canadian dollar, buoyant resource prices, and favourable domestic economic outlook. Overall, our sampled full-service firms show a more balanced commission picture, with mutual fund commissions and commissions from stocks and bonds generating an equal portion of total commissions. We do however see a drop in the percentage of commission revenues derived from mutual funds over the period at the full-service firms. While 53% of total commission revenues were derived from mutual funds (including trailers) in 22, they only represented 45% in 24. Mutual funds, which have been a long-time staple in the Canadian securities industry, have over the last IDA WEALTH WATCH - July 25 4

5 couple years been subject to increased competition. Income Trusts, ETFs, Wrap programs, and various structured products, though not all pure substitutes for mutual funds, have been allotted increased shelf space at the dealers and have attracted capital perhaps otherwise destined for traditional mutual funds. Discounters are less reliant on mutual fund commissions than their full-service counterpart. In 24, our sampled discounters derived only 13% of their commission revenues from mutual funds, up from 11% in 23, but down slightly from 22. Discounters may be deriving a less than proportionate amount of revenue from mutual funds. Though third party research pegs approximately 2% of client assets at discount brokerages held in mutual funds, mutual funds may only be accounting for 1 15% of total commission revenues. This is likely due to the more prevalent use of no-load funds by clients of the discount brokerages. The opposite may hold true at some full-service dealers, whereby mutual fund revenues may be generating revenues in excess of their proportionate weight, as the use of no-load funds may be less common. In absolute dollar terms however, both our sampled discounters and full-service dealers increased their revenues derived from mutual funds in 24. The discount firms increased mutual fund revenues by 25%, reaching nearly $27 million whereas our sampled full service firms increased mutual fund revenues by 35% in 24, topping $266 million. Commissions from derivatives trading account for approximately 5% of total commission revenues for our sampled discount firms. Approximately two thirds of this commission is generated from derivatives listed on foreign exchanges, indicative of the relative breadth and depth in the Canadian derivatives market. Our sampled full-service dealers report less than 1% of commission revenues derived from derivatives trading. This is not indicative of all full-service dealers however. In 24, if we look at all our full-service dealers, including the bank-owned dealers, we see that they generated approximately 5% of their total commission revenues from derivatives. PER CENT PER CENT Expenses Composition of Commission Revenues Sampled Cdn Stocks & Bonds Foreign Stocks & Bonds Mutual Funds Derivatives Composition of Commission Revenues Sampled Full-Service Firms Cdn Stocks & Bonds Foreign Stocks & Bonds Mutual Funds Derivatives Operating expenses (excluding variable compensation costs) at our sampled discounters have also been much better contained than at our sampled fullservice dealers over the past three years. The nine discount firms have kept operating expenses within a narrow band for the period, between $188 and $19 million. The sampled full-service dealers on the other hand have seen operating expenses increase by approximately $1 million over the same time period, topping $4 million in 24. IDA WEALTH WATCH - July 25 5

6 $ Millions Aggregated Operating Expenses Sampled Firms CAGR : -.26 % Full-Service Firms: % $42 $314 $386 $19 $189 $189 Full-Service Firms Number of Branches Sampled Full - Service Firms Atlantic 35 Prairies 178 Quebec 3 Ontario Pacific & Territories Operating expenses are expected to be lower for discount firms than full-service dealers largely as a result of the additional over head costs incurred by the full-service dealers. Our nine sampled discounters operate a total of 19 offices, employing 655 individuals. The sampled full-service dealers on the other hand employ approximately 5,7 individuals in more than 9 offices. The costs of operating and supplying these additional offices, as well as the incremental staffing costs, adds hundreds of millions of dollars per year to the expenses of full-service dealers. Number of Branches Sampled Atlantic 1 Pacific & Territories 2 Profitability The higher costs involved in running a full-service dealer have a significant impact on overall profitability of the two groupings. Profits (before bonuses and income tax provisions) were considerably higher at our sampled discounters than at the sampled full service firms. Overall profitability has however improved in both sectors. Only one of our sampled full-service firms showed a loss in 24 compared to four in 22. Looking at our sampled discounters, we show one firm with a material loss in 24 compared to three in 22. We must also note however that a significant portion of profits within our sample of discount firms is attributable to the bank-owned discounters that were included in the sample, and is reflective of the dominant position the bank-owned dealers currently enjoy in the discount brokerage sector. Quebec 5 Ontario 11 Prairies IDA WEALTH WATCH - July 25 6

7 Aggregated Profits - Sampled Firms 2 $ Millions Full Service Firms Looking Forward The resurgence in online/discount trading is partly a function of improved market conditions but also improved investor confidence. Strengthening investor confidence is vital to all retail brokerages, but more so for the discount firms. Unlike full-service firms, discount brokerages can t rely on the established relationships between client and advisor to keep the clients coming back to the services of the firm. Self-directed discount investors, without the handholding of a professional advisor, must feel confident in their own investment decision making. Discount brokerages will likely continue to leverage technology to assist the online investor in helping them make better informed decisions, thereby increasing investor confidence and attracting additional client assets. Stock filters and alerts, asset allocation tools, and access to real-time data from multiple sources, have become common place today among the discounters. A difficult decision for discount brokerages going forward is where to direct their IT and advertising spending. The industry s collapsing pricing structure will further necessitate the need for individual firms to differentiate themselves in ways other than pricing. Vamping up product offerings and technological platforms seem to be two logical choices. IDA WEALTH WATCH - July 25 7

8 Wealth Market Monitor March 25 - June 25 March 3 Industrial Alliance Securities expands in Ontario with the announcement of a business development and services agreement with KingsGate Wealth Management Services Ltd that will include the acquisition of certain assets of KingsGate Securities. March 28 Clarington Corporation announces the completion of its initial public offering of 6,2, common shares at a price of $13 per share for gross proceeds of $8,6,. March 3 AGF Management Ltd. announces an agreement to acquire the mutual fund assets of ING Investment Management Inc., a subsidiary of ING Canada Inc., which will be merged with existing AGF funds. April 1 Alterna Savings and Credit Union launches in branches across Ontario. Servicing nearly 2, members, Alterna was created when Toronto s Metro Credit union merged with Ottawa based CS Co-op earlier in the year. April 19 First Asset Management Inc. announces an agreement with Affiliated Managers Group, Inc. (AMG), under which AMG has agreed to acquire 1% ownership of First Asset, including their interests in: Foyston, Gordon & Payne Inc., Beutel, Goodman & Company Ltd;, Montrusco Bolton Investments Inc.; Deans Knight Capital Management Ltd;, Triax Capital Corporation; Covington Capital Corporation; and First Asset Advisory Services Inc. April 2 B2B Trust, a subsidiary of Laurentian Bank, announces the signing of an agreement with Acuity Funds Ltd. for the distribution of investment loans. Under the agreement, B2B Trust will make available investment loans to financial advisors for their clients purchasing Acuity investment products. May 3 National bank of Canada announces that Charles Guay will be assuming the duties of President and CEO of Altamira Investment Services following the resignation of Greg Reed. May 4 Norshield Financial Group suspends redemptions on its Olympus Univest Ltd. fund, freezing hundreds of millions of dollars in investor funds. May 5 BMO Harris Private Banking announces the launch of encircle, a wealth management service designed specifically for affluent Canadians in their senior years. May 6 Norshield Financial Group and Aragon Investments Corp. enter into a letter of intent whereby Aragon will acquire the investment management business of Norshield Asset Management (Canada) Ltd. May 17 GMP Private Client Ltd., a division of GMP Capital Corp. announces the opening of full-service retail branches in Toronto and Calgary. The company expects to add more key cities across the country in the coming year, with a target of 15 to 2 advisors with assets of $3 billion by the end of the fiscal year. June 14 Assante Corporation announces an integrated distribution strategy across its three distribution businesses, Assante Wealth Management, Assante Private Counsel and IQON Financial Management Inc. June 22 TD Bank and Ameritrade Holding Corporation announce their agreement for Ameritrade to acquire TD s U.S. brokerage business, TD Waterhouse U.S.A. The agreement also sees TD Bank acquiring Ameritrade Canada s operations for $6 million in cash. June 29 John Hunkin, CEO of CIBC, announces his retirement, effective August 1st 25. Gerry McCaughey appointed to take over. Kym Anthony resigns from his role as President and CEO of National Bank Financial. Louis Vachon assumes the addditional role of CEO. June 3 Northern Financial Corp. announces the appointment of George Garner as Executive VP, Private Client at Northern Securities Inc. Garner will be responsible for growing the firms retail business which represents approximately one-third of the firms revenues.

9 CALGARY Suite Fourth Ave. S.W. Calgary, Alberta T2P J1 Tel.: (43) Fax: (43) HALIFAX TD Centre, Suite Barrington St. Halifax, Nova Scotia B3J 3K9 Tel.: (92) Fax: (92) MONTRÉAL Bureau Place Ville Marie Montréal, Québec H3B 4R4 Tel.: (514) Fax: (514) TORONTO Suite King St. W. Toronto, Ontario M5H 3T9 Tel.: (416) Fax: (416) Jon Cockerline Director, Capital Markets jcockerline@ida.ca Jack Rando Analyst, Capital Markets jrando@ida.ca VANCOUVER Suite 1325 P.O. Box West Georgia St. Vancouver, BC V6B 4N9 Tel.: (64) Fax: (64) Ce rapport est aussi disponible en français sur demande. The Investment Dealers Association of Canada is the national self-regulatory organization and representative of the securities industry. The Association s mission is to protect investors and enhance the efficiency and competitiveness of the Canadian capital markets.