How scale has become a trump card on Bay Street

The chances of survival among small boutique firms are becoming slimmer as costs get harder to absorb

How scale has become a trump card on Bay Street

Small Canadian boutique firms have historically been competitive by virtue of their agility. However, that advantage has recently been eroded away as the industry faces increasing costs that can only be managed through sheer size.

“More than ever, the industry is a scale game that favors the largest players,” said columnist Tim Kiladze in a Globe and Mail article. “It’s an issue that could make the big problems of 2016 seem relatively small.”

To illustrate, he pointed to the example of money managers dealing with ETFs. The assets managed in these funds are increasing exponentially, so large investment firms that manage these funds – such as Vanguard, with nearly $4 trillin globally – have a strong base over which they can spread relatively fixed expenses. With costs spread thin, large ETF players can afford to keep fund fees low, sometimes under 0.1%.

Investment banks were another example cited. “Since the financial crisis, dealers must comply with scores of new compliance and cybersecurity issues,” Kiladze said. “and the back-end systems needed to keep up cost a pretty penny. It’s one of the unspoken reasons why FirstEnergy Capital Corp. and GMP Capital Inc. merged last year.”

While small firms have lost a significant edge over larger firms, the latter still have significant challenges to face. “At an investor day in 2015, [TD Bank CEO] Bharat Masrani stressed that expanding in the United States is ever more important, because it ties into a continental, not just Canadian, strategy,” Kiladze said. Just last year, the bank teamed up with TD Ameritrade to acquire Scottrade for $4 billion – a move that TD Ameritrade CFO Steve Boyle said was a play for scale that would reduce expenses.

Being able to pass on savings from scale has become such a powerful edge among ETF players that even mutual fund titan Fidelity has been forced to fight on their terms, launching six new low-cost funds and slashing fees on current offerings last year.

“Some boutiques will find ways to survive,” Kiladze conceded. “One strategy deployed… is for smaller firms to double down on niche markets. Effectively, go where the big players won’t, and charge clients, or readers, for it. But there may not be enough business to go around… Rivals are likely going to have to pool their costs, too, and that means more mergers.

“Marriages can be hard to pull off on Bay Street, because there’s a lot of ego involved. But when the other option is folding, tying the knot isn’t so bad,” he concluded.

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