The transcript from this week’s MIB: Bonus Pod: Tim Hockey, CEO / President of TD Ameritrade & Tom Nally, President of TD Ameritrade Institutional is below.
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MALE VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week, we have an extra special bonus podcast. Last month, I went to the TD Elite LINC Conference which is a small gathering of about 200 advisory firm executives that run over $300 billion.
This is an annual event. It goes from city to city each year. This year, it was in lovely Dana Point. If you know that part of California next to Laguna, it’s just spectacular oceanfront as lovely a location for a conference as you’ll find.
I had the privilege of interviewing Tim Hockey. He is the CEO and President of TD Ameritrade, a company that serves both individual investors and independent RIAs. They have total client assets of about $1.3 trillion as of the end of the second quarter 2019.
They are the custodian of choice for a number of already RIAs. They are one of my two custodians. We work with TD and Schwab at RWM (ph).
And the other person I interviewed was Tom Nally. He is the President of TD Ameritrade Institutional which provides custody and brokerage services to more than 7,000 independent RIAs. That’s about $650 billion under custody.
This is very much an inside baseball conversation. If you are an RIA, if you are interested in the investment management or financial planning business, then this really is inside baseball stuff that is must listen.
So, with no further ado, my interview with Tim Hockey and Tom Nally.
So, a real brief introduction, when I was doing the homework for this, TD manages or custodies 1.3 trillion in total client assets, 860,000 average client’s trades per day generating about 1.5 billion revenues a year, that is a really substantial set of data and it says a lot about what this organization is about.
So, let’s start with some questions beginning with Tim. So, what does it mean to be a CEO of such an enormous organization? How these challenges differ from other roles you’ve played within the company?
TIM HOCKEY, CEO AND PRESIDENT, TD AMERITRADE: Well, I was at the advisory panel this morning and I said that it’s now been three and a half years since I took on the job as CEO. And having come from the TD Bank in Canada, it’s pretty dramatic difference.
The dramatic difference is you know the phrase the buck stops here, you feel that in spades in this job and this role in particular. An enormous sense of responsibility to all of the constituents, it doesn’t matter whether it’s your associates or your clients or your shareholders or frankly, the communities that all of our people are working.
It’s just that sort of don’t want to let people down I guess is the largest issue with this. The biggest shift from the job if you graduate into this role and the CEO role you get promoted in is literally the time horizon. Your time horizon by definition has to shift out if you want to geek out on management duty (ph) for a second.
The basic premise is organizational hierarchies, the levels of an organization, six, seven, eight, nine whatever it is, they all depend on what sort of time horizon you have. So, if you’re a bank teller, you’ve got a time horizon of one day, right? It’s your shift.
If you are processing a piece of paper as an administrator, it’s a one-day time horizon. If you’re an entry-level supervisor, that second level, then it’s a very short period of time probably a week, maybe a couple of weeks. As you go up the organization, your time horizon has to shift out.
So, if you go from Tom’s level, six, seven levels in the organization, you can have a time horizon of saying how do I transform the institutional business with five to 10 years of time horizon.
And then at the CEO at the firm level, you should be running from 10 to 20 years and that means you’ve got to trying to keep all your balls moving to be able to hit those objectives all along way out with a lot of variabilities. So, anyway, enough geeking out but that’s the biggest drift in this job.
RITHOLTZ: So, let me pull it back from the geek side, when you find out you’re going to be CEO, you say to yourself, I don’t think people really know who I am, maybe I should write a book and tell a little bit about myself. Explain the thought process there.
HOCKEY: Well, thankfully, it wasn’t a book. That would have taken too long. But after being at TD for 32 years and pretty much knowing — everybody knowing me, when I came to TD Ameritrade, I realized there’s going to be an unknown quantity.
And anytime you have a new boss, what does everybody think? They’d say, all right, well, what’s he or she like, what’s the management style, what do they value. And we, generally with new boss, will spend literally months or years trying to figure that person out.
And so, what I did when I got here was to recognize that that was what Tom and the rest of the team was thinking about and I actually spent some time on a very rainy weekend at my place in South Carolina and penned something I called I think it was user’s manual to Tim or user’s guide to Tim.
And it just basically was an open book. It said, here’s what I think about management, here’s what I believe, here’s everything you want to know about me and take a glass of red wine and read it and hopefully it will be helpful and then hold me accountable to it. And that’s the trick.
And so, then I sent that to my leadership team and they then said, well, can we send it to our leadership team, and they said again, we sent it to our leadership team and that was theory behind it. Very, very good practice to go through. I would highly recommend it not just because I think it’s helpful for — as a new leader in an organization.
Actually, I went through it with my wife and my two boys and they’re the harshest critic. And so, they read the first draft and the second draft and they said, yes, that’s not right. So, I changed that, fixed that. But it does force you to be crystal clear in your expectations of yourself and live up to those with your team.
TOM NALLY, PRESIDENT, TD AMERITRADE INSTITUTIONAL: And I can say it was incredibly helpful for somebody who’s trying to understand, okay, who is this guy that just have shown up on the scene that based upon the relationship with TD kind of have some level of familiarity with him because of his previous role and you get to see him once a year in these big giant conventions speak. But then to actually see this and understand who he is as a person, it just gives you a nice roadmap to figure out, okay, how do I interact with him, and it was really incredibly helpful.
RITHOLTZ: So, Tom, let’s talk a little bit about you, you’ve helped ramp TD up to 7,000 independent RIAs custodying with TD Ameritrade Institutional. That’s a giant success by any measure, what was that process like and where did you encounter major roadmap — roadblocks?
NALLY: Well, I would say it was a long slog, We’ve been at this for more than two decades now and I think it all started with just having a really keen focus on understanding what the needs of the adviser actually are and trying to craft the value proposition that delivers on those needs and make sure it was able to evolve over time as those needs change, as the market change and so on and so forth.
And it’s been an incredible ride. I mean, we’ve been trying to take advantage of this massive secular trend towards independent RIA model that is — we don’t think going to slow down anytime soon. It’s great for our industry. It’s great for financial services in general.
It’s amazing, we can see the beauty of just putting the client first, what can happen, and that goes for us, it goes for you. It’s been a wonderful road and we feel like we’re just getting some momentum here as people become more aware of what it is RIAs actually do and how it’s doing the right thing for clients which is fantastic.
RITHOLTZ: So, what were the big surprises on the road to 7,000 and beyond?
NALLY: Well, I think just the change that’s taken place in our space, how advisers’ businesses have evolved and changed. When I first started, most RA firms were portfolio allocation shops. And then they started to become comprehensive wealth management firms adding on more and more services and today, basically, all of you are being asked by your clients to be all things — give me advice on all things that have to do with money in my life.
And think about that, I mean, it’s basically everything. So, we’re trying to keep up with the evolution of what your clients are demanding from you and enable you to deliver great client experience at scale, high quality. So, it’s been amazing just to watch that happened and see how the industry has evolved.
The other thing is just a shift in the trend towards RIAs versus the wire houses. In the last 10 years, wire houses have lost about 11 points of market share and the RIA channel has captured about eight points of that, which is spectacular.
And the more and more consumers get smarter about the relationships that they enter into, that will continue to change. The more advisers recognize that I can do this better on my own rather than being in a captive environment, we’ll continue to see adviser shift and go independent and join existing firms. We’ve seen an enormous amount of capital flow in. So, it’s been an amazing, amazing ride.
RITHOLTZ: So, Tim, you have to balance your attention on two different groups. On the one hand, you have all of RIA clients. On the other hand, there are shareholders and there are owners of TD that need to be satisfied. How do you balance the two of those? Where is the focus and do you ever find a place where it sometimes challenging to strike the exact right tone?
HOCKEY: I don’t think it actually a trade-off between the two. My general philosophy and I think I wrote it down that book was if you take care of your associates, they’ll take care of your clients and then clients then take care of the shareholders in that sort of sequence.
Actually, I can draw a little bit on your last question of Tom to sort of make the point. Everybody in this room is participating in this extraordinary shift to the RIA channel over the last 10 years. I’ve said this morning, it’s tripled in size in 10 years.
But Tom’s business, he started stuffing envelopes …
HOCKEY: … in institutional business, how many years ago now was it, Tom?
NALLY: That’s 25.
HOCKEY: Yes. Twenty years. I wasn’t going to out it but okay. It was 25 years ago, he started in the institutional business for TDA and we’ve grown six times.
And so, you have that sort of focus on doing right by your clients and helping them be successful and the shareholder gets massively rewarded. And I also shared the story with the panel this morning, I thought it was a great one because we actually went and did a long-term view of our performance as a company.
Here we are as a wealth management firm. We should take a look at our own performance and see how have we done. So, here’s how the math works and I think it’s a funny story.
We IPOed as a company in 1997, adjusted price about 50. So, here we are now at 50, unchanged (ph). So, there were 4,600 public companies back in 1997 and those intervening years, 2,400 of those 4,600 were bought. So, they consolidated into the others. 1,100 of those 4,600 companies basically were delisted. So, they’re gone.
So, about 1,100 companies left, Bristol one of the 1,100. And if you say, all right, what was the size of those companies? Of those 1,100, there was about 600 that had the similar market cap that we did when we IPOed at about $200 million market cap. Now, we’re 30 billion.
So, out of those 600 companies that remain, we rank order them in terms of total shareholder return and we are number 11 out of 600 over those 22 years since our IPO. No big surprises to — who’s number one, Apple.
But I think that’s long-term success in performance as a company going back from the IPO days comes from being a combination of the right things, great leadership and I’ve only been here in three years but guys like Tom, 25 years, and Fred and Joe and our founder riding a wave of success, focusing on your clients and the value you can deliver and the shareholder gets intensely rewarded for that. So, this has just been a great ride for us.
RITHOLTZ: So, Tom, let’s talk a little bit about some of the elements that have led to this success starting with technology. If there’s a question I hear from advisers more than anything else, it’s how can I be cutting edge and provide the technology I need to run my business and my clients want without getting distracted by every new shiny object that comes along.
NALLY: Yes. I mean, it’s a great question. I think our view is technology is the great enabler, right? It enables you to deliver more services to your clients and have a more robust value proposition.
And I think you all must need to break that into two different things, right? The first thing is there’s probably a lot that are mature technologies that are out there that you can take advantage of now in the immediate term to improve your efficiency, your client’s experience many times that’s one and the same and work on implementation.
The second half of it, you really need to keep your ear to the tracks around what our consumer trends, what are the expectations of the consumer not just in financial services but in just the way they interact in their life with Amazon, Google, Apple, a lot of the top companies to see how those trends are evolving and then work with the firm like ours to give us insights into what it is that you need.
What we’re seeing is a lot of firms getting pushed into adding these additional services. So, how can we partner together to deliver new technology at scale that you might not be able to do on your own? So, I think there’s a combination of factors that you need to focus on there.
But technology really is the biggest opportunity out there because of the thing that everything in your business is pretty much going to be automated, which is a good thing. Technology is a tool for all of us to utilize across every facet of whether it’s trading, rebalancing, risk management, CRM, portfolio, reporting the whole nine yards, and that just freeze you up to spend more time deepening relationships with your clients, which is what clients really care about.
We have one advisor who say to me one time and it really stuck with me and I continue to bring this up, nobody ever walks in the office and says, I want to beat the S&P by five points. They walk and say, am I going to be okay, and technology enables you to have all of those tactical things done in an automated fashion so you can spend the time really getting to understand what are the hopes, dreams, fears of those clients and make sure that you’re meeting those needs and delivering on what they’re most concerned about.
RITHOLTZ: So, you mentioned rebalancing as a technology, how do you decide internally, hey, we can build something that will push a button and automatically rebalance and do some tax loss harvesting or maybe there’s a company out there that might be much more mature and further along and it will be faster, more efficient to buy it like I read about. How does that decision build your buy be made and what sort of elements are you thinking about?
RITHOLTZ: See, from our perspective, if we go through that equation, I mean, we really are looking — if we’re going to make an acquisition where there’s got to be white space where we can be an industry leader and it fits within our core capabilities of the services that we tried to deliver and get strategic advantage.
Like with iRebal now, our iRebal has probably more than 50 percent market share in that rebalancing space. So, there was an opportunity there. If we don’t think that we can carve that out for ourselves, we would rather have an open which our technology platform is very open architecture. You can plug in many different types of systems.
We’d rather partner with industry leaders and then work to give advisers guidance on how do you put the best technology stack together that meets yours and your client’s needs. So, it’s more — it’s a build-by-partner type arrangement.
Now, from a build-it-yourself perspective, we do try and be very focused around sticking within our swim lane so that we cannot have to spread our resources too thin and make sure that we’re not leaking into areas where some of our technology partners within the space are going to do a better job than us. So, it’s being really focused and understanding how you’re going to deliver value.
HOCKEY: Just to add on a little bit, the really three types of decisions, three types of acquisitions you want to make. The first is when you need to do a strategic pivot. There’s just your end-of-life with your particular business model. I’ll say, okay, I’ve got the capital, I’ve got the cash cow, now, let me buy something that gets me a brand-new capability. No synergies. You invariably pay too much for it. But in the long term, it pays off because you’re safe.
Second one is the scale play, right, and the third one is I had capability at. I remember back when we did this Scottrade deal a couple of years ago, the “Wall Street Journal” article the day after that was announced was written by an article — by a journalist who said, they’re investing too much in the old model as in the consolidation that scale players got to trade on ourselves. They should have bought a robo-advisor.
And, of course, at that time, they were saying, we should have spent $500 million thereabouts for — in a robo-advisor player with no assets to speak of. We looked at that and we — I sort of laugh because the creation of the value by doing the Scottrade deal was enormous and to make the equation of buying a robo player at 500 million versus building it yourself in terms of the capability at about 5 million.
HOCKEY: So, you would have paid 100 times what the — what it would take you because we already had the capability to put the pieces together and spend a fraction of the price. So, that’s sort of the equation quoted (ph).
RITHOLTZ: So, since you bring up robo, let’s talk a little about Schwab has an automated solution, Vanguard crossed the 100 billion in that, what do you think of the space? Is this the sort of thing? Betterment recently pivoted and began offering a white label version of their robo to advisers. What do you guys think of this space? Is this something we could see a little higher profile or not in your swim lane?
HOCKEY: Yes. So, we’ve long thought that robo isn’t a business model, it’s a technology that is just another version of what Tom was talking about.
RITHOLTZ: It’s a tool.
HOCKEY: It’s a tool that comes along and it provides yet more automated versions of services. And so, there are different versions of that. If you go fully automated, the current maturity of our space and our clients’ desire is most people try the fully automated model and then realize you need to bolt on a human element to make it really successful.
Because of the pricing of the business models, my view is you can’t really get to scale until you’re at a 50 or $60 billion asset level and that’s really tough for the sole providers and the fintech upstarts to get to that level. There will be one or two survivors in my view of robos as a business model. But what you see the maturation in the industry which is all the established players come to the party usually a little later and they offer that capability and they already have the distribution strength. They have the brand. They have the client perception and then they tend to gather assets a lot faster.
NALLY: What’s really interesting though, just to add on to that, we were — because we have an open architecture technology platform, we were one of the first adopters to go out there and partner with about a dozen different robo technology firms that some were going directly after the consumer and were going to be an RIA themselves and found because of all the challenges that Tim just mentioned, they don’t have the distribution, the brand, the capability, they quickly pivoted to, hey, now, we’re going to distribute through advisers and they were expecting advisers to have a bifurcated business model where they were going to go down market and utilize the robo as the solution while they’re keeping their high net worth offering the same and they didn’t really see that materialize.
So, we saw a very low adoption and we actually have a product for our retail clients and it was built with the ability to pivot and deliver those capabilities to advisors if the demand surface and it really hasn’t come to fruition. We haven’t seen a lot of adviser adoption of that type of technology because they just haven’t figured out how to bifurcate the market and so on and so forth.
RITHOLTZ: So, both of you have made reference to what’s going on in fees. There’s been a transition to some degree from active to passive. But the bigger transition seems to be from expensive to cheap. How much lower can fees get? How cheap is cheap? Tim?
HOCKEY: Well, I think there’s a pressure on price, period. It doesn’t matter what sector you are in the industry, let alone in wealth management whether it be asset management, whether it be commissions on trades. There’s a constant pressure.
So, why is that? Well, because there are clearly excess rents that are being earned. If a competitor can enter the space, eke out a profit, a rational profit and a reasonable profit and a return on their capital and at a lower price they’re going to do that. That is absolutely a — that’s a good thing for consumers. That’s a good thing for the economy to have a price competition.
So, what is it forced you to do? Well, it forces you to get big enough so that you can have scale to be able to match that on the way down. It forces consolidation in the industry, which is not always good. But it certainly keeps everybody on their toes. I don’t think the pressure is going to abate because it hasn’t to date.
We were formed as I’d like to say back to that 1975 date when our industry was formed when the regulations changed. Think about it, the regulation that was changed was allowing price competition amongst brokers.
I had a chance to get a copy of — it’s a galley copy, it’s not really published, it’s the autobiography from our founder. And so, I’m reading through it and I’m getting these sort of interesting little anecdotes from when — pre-IPO in 1975 and the reason why the term discount brokerage actually got coined, I didn’t realize this, it was a derisory term that was coined by the full-service firms because it was supposed to be negotiated commissions but they just said, no, you’re a discount broker, you’re just discount, notably cheap as in no value add.
And the time has happened and back then, of course, trades were 50 bucks, 60 bucks a trade, 75 bucks a trade. And that was a huge …
RITHOLTZ: That’s the discount.
HOCKEY: That was — yes. Discounted price in 1975. And here we are now call it 90 percent off that price point or 85 percent off that price point in the intervening period of time and we’re still talking about the prices are going down to four, three, two, one, zero.
My own view is there’s no such thing as a free lunch. There never has been. There will always be a margin that needs to be eked out if there is value provided to clients and clients will happily pay for that value. It’s more achievable.
RITHOLTZ: So, let’s talk a little bit about that because I love that topic. I think people get so enthusiastic about cheap which is great they don’t realize free is misleading because nothing is free.
RITHOLTZ: You’re paying somewhere. Some of your competitors will go without being mentioned offer free asset allocation, free robo-advisor and then there’s a little asterisk and it turns out that free is kind of expensive. You’ve discussed this in public in the past. What are your thoughts on free?
HOCKEY: Yes. So, again, theory from my point of view is you don’t want to just compete on absolute price because trading (ph) price itself is a race to the bottom and it just means you have to be cheap, cheap, cheap, cheap, cheap.
If you’re having a choice between competing only on price — primarily on price or on product or on the client experience and it is a race to the bottom, I’ve said to my team many times, we think we can create the most value and stand out from a client experience point of view in terms of all the capabilities we had for our clients. If we had enough value, you will pay a reasonable price with that value.
By investing that return, if you will, for the next little while if prices go down, let’s just imagine that five years from now, prices are going to go down to zero. Now, there’s two ways to compete, product and the client experience, because price is now equated to zero for everybody.
And if that’s the case, you better wish you’ve differentiated yourself on the client experience in the intervening time because now how do the cheap players compete, right? They’ve been very cheap. They probably don’t have the differentiating factors. And as a result, they’re going to be stuck a little bit making a difference.
So, having said that, there is no zero, there is no absolute free lunch. And as you said, there are different pricing models, some are straight up front and some of it has got hidden costs that the client does end up playing somewhere.
RITHOLTZ: You can jump in if there’s …
NALLY: Yes. I mean, just two things, I mean, from an RIA perspective, what’s interesting is it’s one of the areas in financial services where you haven’t seen a lot of price compression but what you’ve actually seen is just being — advisors being forced to add more services in order to differentiate their value proposition with that expense which makes technology and efficiency that much more important so that you can maintain profitability and so on and so forth.
So, technology really is the key and we think that’s going to continue to happen. I think you also need to look at relative value. It’s amazing to me when you see one of the major wire houses just lower the cost of their basic out-of-the-box separate account program from 275 basis points to 250 basis points as the max fee.
And they didn’t go to 150, right? So, it lets you know that people are still paying that price. And if you think about what our consumer is getting when they’re going to an RIA firm that uses TDA and the services that they get and the fact that their advisor is sitting on the same side of the table with them and the technology experience they’re able to have on a relative basis, they’re basically paying less than half for a much better experience. It’s all about relative value I think.
RITHOLTZ: So, you raised a valid point and I want to throw it towards the audience, how should advisers who are more or less charging similar fees communicate their value add to both clients and prospective clients?
NALLY: It’s one of the biggest challenges that we have because what’s happening is as advisers add more and more services, some of those services become commoditized depending on what type of business you run.
There are many firms out there that are just not trying to generate alpha, just utilizing index funds and so on and so forth but yet they are still charging a percentage of assets under management. But where clients find the most value is in the comprehensive wealth management and that financial planning and the estate planning and so on and so forth.
So, we’re seeing firms start to figure out, hey, we need to experiment with minimum fees, we need to think about maybe broadening should be based upon total net worth rather than just investable assets because you’re advising on so much more of a holistic view of the client’s life and their wealth.
So, there’s a lot of challenges out there and especially with the introduction of the robos where you hear, hey, this robo will do everything for 25 basis points, that’s tough to market against. But it’s the new client that you have to be worried about.
The existing client already realizes, my gosh, my adviser does so much for me, my life is in order, I couldn’t imagine not having the services they provide, I would never go to a robo that’s charging 25. So, articulating that value proposition and the differentiation is one of the big challenges you have out there.
RITHOLTZ: So, Vanguard wrote a piece a couple of years ago, I’m sure half of the room is familiar with Advisor’s Alpha and it raises the perspective of the behavioral counseling is worth more than the asset allocation, more than stock picking, more than all those things because if in a downdraft you panic and sell and we know tons of people who dumped stocks in March ’09 and didn’t get back for years, none of that matters if your behavior is inappropriate. So, how significant is the behavioral side of what everyone in this room does for their client?
NALLY: I mean, that’s where the juice is squeezed. That’s where the money is made. That’s where the value is delivered. Whatever you want to say. I mean, it’s amazing.
There was a great staff from Morningstar, too, a client can have 29 percent more income in retirement if they hire a financial planner. I mean, that is an unbelievable stat and think about it, most people hire a financial planner 20 years too late, right?
They’ve already made so many mistakes in their lives that all of a sudden they’re 45 years old and now it’s time to go hire a financial planner. If we can get people engaged earlier and getting to avoid some of those mistakes, make the right decisions, I mean, that value will go up exponentially.
So, I think it’s all about the coaching, don’t worry, we’re playing the long game, we’ll see what happens towards periods of volatility. Most advisory firms shift from going out there and going after organic growth to, hey, we’ve got to placate the base, we’ve got to make sure that our existing clients are keeping their eyes focused on the longer time horizon and the long-term goal. We should anticipate periods of this market volatility but it’s not going to knock us off track. So, that is invaluable. It’s almost immeasurable.
HOCKEY: Yes. I can’t reinforce that point enough. The power of a discipline process that you work through with your clients or just generally all of us in life, it’s the compounding effect of those incremental things that you can do. They’ll make the dramatic difference in the longer term and that, to your point, is largely holding people accountable, it’s that coach, it’s that discipline they all coaches whether be your financial coach or your sports coach or whatever else enables you to do because let alone (ph) advisers, clients and ourselves as individual humans won’t follow that same discipline.
RITHOLTZ: It’s just human nature to shoot ourselves in the foot and the adviser there to stop that.
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RITHOLTZ: So, speaking of shooting yourself in the foot, we know lots of advisers like bells and whistles and they want more and more and more on their frontend and backend of the technology. What is the biggest request you’re seeing from some of the new tech? What is this room asking from TD?
NALLY: Well, I would say there’s two things. One is around just automating all of the processing, right? Making sure that we can no longer have to be doing data entry to open a new account or changing an address, right, and like that. How can we have a digital environment because that creates efficiency for all of us both at TDA and for advisers but it also leads to a better client experience.
Tim was mentioning earlier, we spoke at the advisory panel where one of the first times you have the intersection of investing in efficiency and improving your client experience are kind of one and the same. So, those investments are really paying off. It’s a great way to look at it because that’s the kind of stuff that nobody likes to do that data entry work, it’s kind of silly in the technology world that we have today, the capabilities, we shouldn’t have to do that. So, that’s the short to medium-term.
The second thing is as folks are getting pulled into these adjacencies that maybe they didn’t give guidance on in the past, things like long-term care and elder care and college planning and things like that, even around just managing your healthcare, what plan should I sign up for? These are expertise that advisers didn’t necessarily have in the past.
So, looking for ways to deliver those services at scale with high quality, that’s the thing that we’re really exploring now. So, we’d love to hear from the audience over the last couple of days, what are the things that your clients are pulling you into as they ask you to help you navigate everything within their financial lives and how can we help you solve some of those problems.
RITHOLTZ: So, when Vanguard and their CEO started recently Tim Buckley, I got to do a 10-question Q&A, and one of the questions was what keeps you up most at night, his answer kind of startled me, it was cybersecurity and hacking.
So, first is what keeps you up at night and how concerned should we all be about digital security?
HOCKEY: Yes. I would say if you ask any CEO, Barry, 90 percent of them today would say that exact same answer, me included. And you have to ask yourself why, it’s because it’s one of those nightmare scenarios that even though we all — we spend literally hundreds of millions of dollars on this, it’s an arm’s race.
And the other side is very much incented to try and keep you on your toes because if they find a little crack in the door, they can not only rob you and your clients but you have an idiosyncratic reputational event, right?
So, it’s one thing to be — we have a market meltdown and then anybody that’s in the wealth management space basically rides that wave under the rocks. If you have a cybersecurity event, it’s usually you have been attacked and your clients have been exposed and that’s just a nightmare, an absolute nightmare scenario.
Now, I can tell you, the counter argument to that and it might seem a little strange but as time goes on and there are a number of these data breaches, I think consumers are becoming immune to the next headline that sort of says, hey, 100,000 cards here or a million records here and my — the IRS database was breached and the Target data — and the people sort of go, wow, you had another one.
But it’s like all things. Even though these incredibly bad events happen to the company, I think consumers are actually becoming numb to that effect and partly it’s because you don’t often see that the next follow-on article to that, Target has a billion whatever it is credit cards being breached and 150,000 clients had their financial records erased or money stolen.
So, the headline risk is huge to CEOs and so we never want to be in that and yet what’s fascinating is you don’t actually see as many of the downstream implications of those breaches coming to fruition. And so, I’ve always sort of curious as to what’s happening to all that data and why is it not being exploited to a much greater degree.
RITHOLTZ: Are we seeing advisers and clients becoming a little more sophisticated about security?
NALLY: I think we absolutely are. I think it keeps a lot of advisers up at night as well and one of the things that we’ve seen is we’ve seen the perpetrators move from going after a TAA to going after advisory firm and now, the weakest link in the chain is the end client itself.
And we see on a daily basis, clients would have their emails hacked and they send an email to the adviser, the bad guy, and say, hey, I’m in Spain for my sister’s wedding and I need hundred thousand dollars wired immediately to this bank account. And it’s amazing how many people will just send those instructions in and next thing you know, the money is gone.
So, you’ve got to be really vigilant in making sure that you are verbally confirming with the client that this is in fact you because email hacks are happening dozens of times a day that we see. Luckily, we’re able to prevent most of them because advisers’ awareness has gotten much better. But it’s a serious issue.
HOCKEY: Yes. The social engineering way of hacking in is way more productive in the sense that they find out the name of the principal of the firm or the CEO and find a way to spoof your email, get that information and people to say, well, obviously, it’s not a hack per se, might just got an email from the CEO saying wire this money or whatever it is.
The alternative is broadscale. You’ve got to breach the people get directly in. So, as firms, we are now doing much more — first of all, we’re starting with an assumption that says the bad guy is in the walls and what do you do knowing that you’ve already been reached.
Now, that’s a supposition because we can’t find them but it changes your mindset as a firm from a security point of view if you assume they’re already inside the mouth (ph). It’s the first thing.
Second thing is we started actually doing bug bounties which is literally, unlike having a red hat team or a white hat team, black hat, depending how you define them, of internal players to try and find your bugs, you just pay money to people who tell you they found one. And we’re actually finding that we’ve — I think we’ve taken the cost of detecting a bug down by about two thirds and we’re just essentially incenting bad guys to come in and poke at us and then come and tell us and we’ll pay them.
Way more effective than just waiting for a very small subset of people with technical skills to actually breach you and find their way all the way in.
RITHOLTZ: Sounds like it’s working. Let’s shift gears a little bit and talk about cash because people have been discussing raising cash, carrying cash, cash is king (ph), it used to be that cash had a fairly decent yield on it. Some of your competitors have changed their rules that their cash sweeps no longer yield much more than a few bits.
If you want to see a return, you have to actually go out and buy some short-term bonds typically through ETF. Tell us about what’s going on with cash sweeps, what are you guys going to do and what do you think about what some of your competitors are doing.
HOCKEY: Yes. So, let me start with just the macro trends. It goes back to the point about how does a firm get paid. And in a world where — let’s go all the way back, in a world where you’re getting paid $30 or $40 or $50 a trade and interest rates are on absolute level higher, then you’ve got a more varied revenue stream. And when you have a rate — a period of rising interest rate, your betas tend to be higher.
What we’re seeing now with other revenue forms as we said a few minutes ago being compressed and an ultralong period of low interest rates then what we found this most recent cycle as interest rates start to rise that the beta has been quite low. And now, they’ve been higher in forms of cash where there is a higher degree of customer sensitivity to put in that cash to work.
And in our particular space, because it tends to be a transactional cash waiting for the next opportunity to make a trade if you’re in retail, then that is very sticky cash and it’s largely the way that the firm has become more and more compensated for the service it provided.
And so, if you imagine a world where if commissions were to be zero in the brokerage space, cash would be even more important as a way of getting paid and you’ll find even less beta in terms of the buyer of that cash, which puts actually the industry at great strategic risk because interest rates fluctuate and you can have 300 basis point short-term rates or 500 or, as we know, zero for a period of time. So, that’s the trend that’s been happening in a macro basis.
NALLY: Now, what we do from a cash perspective, we actually look at the differentiation between transactional cash and investing cash recognizing that some advisers want to keep a portion of the client’s portfolio. So, the sweep is the BDA, the bank deposit account, but you can actually go out and buy a purchased money fund which yields considerably higher but you have to go out and actually take action to put that allocation in place.
RITHOLTZ: So, let’s talk a little bit about ESG. We’ve been hearing that this is the new wave now for, I don’t know, 10 years. It seems there’s a lot of chatter about it but there hasn’t been a whole lot of uptake from either the end investor or the adviser. What are your thoughts on environmental, social, and governance? Why has it been lagging? When we look at Europe, they’re far more aggressively invested in that space than the U.S. is.
HOCKEY: Let me start. From a public company point of view, we are feeling it from our investor base. And so, they just focus on what are you doing and wanting to understand what TD Ameritrade’s position in this space is actually causing us to spend more time putting energy into it.
So, it shows you that the underlying trend is absolutely there and you could say that there has been, albeit slower than elsewhere in the world, there has absolutely been a trend more to ESG investing. Remember, 10, 15 years ago when this was very nascent, the cost in argument was you can make those choices but you will be subperforming on your investments as a result of having traded your moral case off against your — just maximizing your returns.
That’s less true now and the trend certainly with the younger investor has been very much to put their money where their morals are. And so, I think it’s growing, it will continue to grow and this is how I’m feeling as a public company CEO and we’re seeing it in our business as well, it’s growing.
NALLY: And we are starting to see advisers especially ones that serve a younger demographic trying to incorporate that into their value proposition without a doubt. I mean, if you look at some of the things that are really important to younger associates even when you go apply for a job somewhere, they want to know what your company stands for, what your mission, your values, your purpose I would say more so than previous generations and I think that leaks over into their investing philosophies and so on and so forth.
So, I think the trend will continue to evolve and gain more momentum as some of those younger folks gain more assets on a go forward basis.
HOCKEY: They will challenge leadership as they should on what value you bring to your clients, are you on the right side of causes and issues, are you on — do you take a stand, the express desire for leadership to take stands on issues. Buy your own associates, let alone your clients but much more buy your own associates is stronger and stronger and I don’t think it’s abating.
NALLY: And I will tell you, I mean, just from an adviser perspective or serving advisers, it’s been an incredibly motivating factor for our associates to know that they pop up out of bed in the morning to help the best people in financial services do the right thing for their clients.
It really makes a big difference and if you want to get associates to feel good about what they do, just talk about what you do for your clients and obviously, your associates get it. But it’s incredibly motivating just to be able to serve you guys when you’re sitting on the right side of the table and sitting on the right side of history. It’s really motivating.
RITHOLTZ: So, I was originally a bit of a skeptic when it came to the issue of direct indexing. I’ve been hearing about this for a couple years. My friend Dave Nadig at ETF.com has been talking about this for a while.
And then over the past year or two, I’ve noticed we have a client who’s the general counsel of a big oil company, his whole life is exposed to oil and energy, wouldn’t it be great if we can just dial down the energy in his portfolio. We have another client who works in finance who’s value manager, his whole life is small-cap value, really exposed to that.
What are your thoughts about direct indexing and is this something that could basically challenge ETFs?
NALLY: I think you’ll see two things. I think you’re going to see ETFs that are specifically focused on — and they already are out there eliminating some of the sin thoughts and so on.
RITHOLTZ: Low carbon.
RITHOLTZ: Exactly. There will be some that are just more broad based and then you’re going to have very specific things that people can pick to eradicate from their portfolios.
But then I think what we’re also looking at and I think the whole industry is exploring is how do you do this through technology in a cost-effective way so you can have clients do that on a custom basis. And we see a lot of our clients are starting to do that manually and figuring that out. It is becoming part of their value prop and it’s some of things that we’re having a lot of discussion around within our organization on how can we help with that.
RITHOLTZ: And any thoughts about that direction? Is that something — if you have individual with a thousand stocks instead of eight ETFs, I have to imagine there’s a whole lot more complexity and a whole lot more cost that goes into that.
HOCKEY: True. But, again, to Tom’s point, first of all, understanding what is the unmet need that the client has, what problem are they trying to solve for and then leverage technology to make it cost efficient to provide. It’s that simple whatever the need of that particular day is.
Yes, it can be costly. But if you can actually deliver a better solution and you apply the assets and the capabilities you already have to do that in a way that meets the need, there’s a margin there to be had.
RITHOLTZ: So, what is the most — this has clearly been a period of giant change over the past 10 years certainly since the financial crisis. We, in this room, see it from a certain angle. I have to imagine your perspective is slightly different. What has been the biggest surprise of the best decade? What really kind of made you step back and say, wasn’t expecting that?
HOCKEY: Well, when the financial crisis happened, I remember it very acutely as I’m sure everybody else in this room does, my perspective was I was a Canadian banker at that time and Canadian banks largely avoided the accident.
And so, we had sort of a view on what caused the accident largely elsewhere in the world, what you call the mortgage crisis whatever you thought was the case, CDS is another. Since then, there is a lot of things that happened that were completely knowable in advance.
The size of the event itself being the second greatest financial events in our history certainly and you know if you look back through history, all of the regulatory agencies that are in the western civilization were created as a result of those accidents. And the greater the accident, the more the regulatory repercussions.
And so, you could see that happening from day one that there will be implications. What we probably didn’t see happening was just the sheer flatness of the rebound. I mean, here we are 10 years later, most of you see all of the data for all of the other recessions, they’re D but they’re basically a V.
These ones look like this. And so, here we are literally this month and makes it the longest recovery and there’s lots of debates and discussions about, okay, well, can you go for 10 years plus a month without having a bull market to tip over because all the other ones have.
My own view is that because of the sheer flatness of this recovery, there is a chance that it could — we could eke through the next in a while, that’s not my base case I should say. My base case is that we’re actually going to be going into a bit of recession.
But there’s a chance that we could actually slide through this with this next robo-client back to the levels we’re at. So, the surprise to me is just how long it takes for this country and for the world to get back on its feet to where it was after you have that slice of an impact.
And yet that’s been our history. We have — that’s the great thing about capitalism, it has this amazing sort of wealth creation and then there are big crashes that happen every once in a while, and then you have to pick your feet back up and off you go.
NALLY: I would say a little closer to home is that financial crisis was kind of an accelerant for the RIA flame. If you think about it, those big wire house brands were significantly damaged as a result of that. Consumers started to become far more aware of the relationships that they had and how advisers were getting paid.
The advisers that were in those captive environments said, hey, I can do this better on my own and my clients are more loyal to me than they are to the brand on the roof. So, I think this — the momentum that came out of the financial crisis for our space was really dramatic and it’s been fantastic.
RITHOLTZ: So, let’s talk about this space and the shift from the broker-dealer model to the RIA model. There’s been new regulation. It’s not quite finished. But the word is that regulation best interest is coming forward. It turns out it’s neither a regulation nor best interest but it’s a challenge to the fiduciary rule that’s on our side. Talk a little bit about the fiduciary rule and what is it mean when the brokerage side is trying desperately to sound like they’re under a fiduciary obligation.
NALLY: Yes. So, tomorrow, the SEC is going to vote on this and Skip is in Washington and he’ll be there at the event. And it’s pretty, pretty incredible.
But we believe, right, that there’s still delineation between the ’40 Act and Reg BI or however brokers are governed in the future and we do think that there should be a heightened standard for the way brokers behave. But we’re very thoughtful around making sure that the waters don’t get muddy because that could be a bad thing, right?
You don’t want a situation where a broker who’s really acting as a salesperson is positioning themselves as an adviser and saying, yes, I have to put your best interests first and maybe they’re not. So, we’re concerned about consumer confusion and what that may bring to the table.
But, of course, we want to make sure that there’s elevated standards out there as well. And one of the challenges that we saw even with the DOL is great in spirit but implementation was really going to be a challenge. I remember actually in this room a few years ago where we had somebody give a presentation for an hour and a half, one of the leading attorneys on what the DOL rules are going to look like and people walked out of here more confused than they were when they walked in.
So, I think keeping it simple is something that will be very important. I know there’s the four-page disclosure document that’s going to be required. So, we’ll see what tweaks ultimately get made. They’re talking about potentially making tweaks to incidental advice, what is that really means, seems a little bit like the Merrill Lynch rule that we saw some years ago.
But ultimately, I do think it’s a good thing to raise the standard on brokers but want to make sure we keep that clear delineation between the fiduciary standard and the ’40 Act and whatever it is that’s going to ultimately govern rules.
HOCKEY: Yes. In macro level, I’d say it’s going to be a better thing generally for consumers, not as good a thing for the RIA space. And what I mean by that is the confusion that consumers will have about the advice and what is advice — again, we think of it because we’re all inside baseball here. We all know the regulations. We know that consumers don’t care or they just assume that the adviser starts with their best interest.
You say the word fiduciary and they don’t really get what that is. It’s just — it muddies the water. So, the distinction for the RIAs from the broker-dealer model is going to be — if it passes, it’s going to be, in my view, a little bit muddy.
But, again, you can say the consumer would be better off if it drags the brokerage community, if you will, closer to doing better for the client and more in their best interest. But it won’t be necessarily as distinctive an offering for the RIA industry.
RITHOLTZ: Am I too cynical when I say reg best interest is designed to muddy the waters on purpose? It’s not best interest. It’s clearly not fiduciary. It sounds like that name was designed to be confusing.
HOCKEY: I don’t know if that’s the case. I think it was very much a reaction to — look, the Department of Labor rule was well intentioned but it was flawed in execution. It created more confusion because you were dividing it down the ERISA line as opposed to across all types of investments.
And so, this is an attempt to try and find frankly a compromise solution and we know what — you get it when you get a compromise solution. That’s, what do they say …
RITHOLTZ: A camel is a horse designed by a committee.
HOCKEY: There you go. That’s the best example of exactly what you’ll end up getting.
NALLY: But I think also if you look at what’s happening in the states, right, I mean, you’ve seen states now start to propose fiduciary rules which shows you there’s an appetite, there’s a demand, something’s got to happen.
And in the states, that’s actually a little bit scary because imagine if you’re all of a sudden dealing with 52 different standards, especially for advisers that operate in multiple states, firms like TDA obviously that operate in every state and even services that we provide to our clients that want to be in control and do it themselves, things like research that we provide or education materials could potentially fall under a fiduciary standard which doesn’t make a lot of sense and then you start limiting consumer choice. So, we have to be careful of how these moves going forward.
RITHOLTZ: So, now, let’s — in the last five minutes or so we have, let’s look forward, what does this industry look like five, 10, 20 years in the future?
NALLY: So, I think you’re going to continue to see the RIAs grow and mature. I think you’ll see far more automation that we see — than we see today. I think basically everything from a tactical perspective or a day-to-day operational perspective will be done on an automated basis.
And the real value that’s going to get delivered is going to be with that person-to-person relationship. That empathetic human relationship is really where I think the value gets delivered today and I think that that’s going to be exacerbated in the future.
I think it’s going to change where we make our strategic investments as business leaders. I think it’s going to change who we hire based upon their skill sets. We’re talking about this a little bit earlier. It’s no longer going just to the business schools and hiring that person who’s a quant-type thinker. It’s about going to the humanity schools and pulling in the psychology majors or sociology majors, the people that have a knack for developing relationship with clients to deliver on those services.
So, I think there’s going to be a lot of change in the space. I think demographics is something that we need to take a serious look at. How do we make sure that our industry is more reflective of the trends of the population in the United States and where wealth is concentrated that’s going to shift?
So, there’s going to be a lot of change over the next five to 10, 15 years. But I do think this space is going to continue to win because it’s just the better business model. Put the client first and good things will happen.
RITHOLTZ: Tim, what are your thoughts looking out a few decade (ph) or so?
HOCKEY: A few more ads, there will continue to be consolidation in the space because the investment required to deliver on what Tom was just saying is going to get more and more and more and it’s going to be one — you don’t want to spread it over more and more clients because that’s the other big trend which is it will continue to get cheaper for clients.
And so, if you have the scale, you can continue to provide those additional value-added services for the clients and enable demand with greater transparency. You, all of us collectively, working in their best interest for low price is just what they will demand, it will be the inexorable trend and technology is going to drive that.
RITHOLTZ: When you say consolidation, are you talking at the custodian level, the adviser level or across the board?
RITHOLTZ: Yes. It requires scale and we’re going to continue to see both develop and that’s what’s absolutely necessary (ph).
HOCKEY: Yes. I think about starting up any size company now that’s trying to compete in that milieu of a price point that is maybe a third of what would have been 10 or 15 years ago. It’s tough.
And so, I think it will just continue to be you’ll be driving more and more value. You can create skill quickly through technology and what it can provide you. You can just buy pieces. We often use the case that you’ve got the Ubers of the world and the Airbnbs of the world, these massive global scale players, and they didn’t exist five or 10 years ago because they need it together in assets and through technology. But scape from a — for lower and lower and lower prices is going to be incredibly important.
RITHOLTZ: And I save this for my last question because I get it all the time from clients and I know I do a terrible job answering this. Can you explain the historical relationship between TD Ameritrade and TD Bank?
HOCKEY: Yes. Well, actually, it’s a great point. It is a point of confusion for us, right? So, back in 2015, when TD, they had TD Waterhouse, of course, sold its DI business, direct investing business, to Ameritrade and took back 32 percent of the ownership. So, now, TD Bank has 42 percent of the ownership.
And you’re right about the confusion because we often have clients walking into our branches and saying, hey, I want to deposit a check for my bank account and they have clients walk into their bank branches on the East Coast and saying, hey, I want to talk to my adviser about my brokerage account.
And so, the historic relationship is powerful in the sense that what it allows us to, TD Ameritrade, is to be focused and we have what we call a capital light model and by taking these deposits, sweeping them over to a bank has meant that we haven’t needed to become a bank.
And if you think about that environment we’ve been over especially since the financial crisis, the regulatory scrutiny and pressures on the banks and some of our competitors have felt that sting quite acutely over the last decade or so, we’ve avoided much of that accident.
We’ve avoided the additional regulatory pressures. We can be generating higher return on our equity by having this relationship not becoming a bank and it just allows my management team to very much focus on being a better provider of our institutional services and being a retail broker.
RITHOLTZ: That’s my conversation with Tim Hockey and Tom Nally. It really was quite interesting and I learned a lot, meaning a lot of people who have been with TD as a custodian for quite a number of years. Not very often we get to stop and think about how our assets are custodied and really it’s a key part of asset management especially from the registered investment advisor side.
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