Brooke’s Note: It works for me. Schwab goes out and buys a hot, small, little known manager that it learned about through a custody relationship and then throws the power of its brand, advertising dollars and branch presence into making it a big manager. Advisors and retail clients like having something a little special and Schwab gets better profit margins because of the vertical integration. But I’m believing Walt Bettinger, who I was able to collar at the Tiburon CEO Summit when he says that it’s not as if his company is creating a (my word) roll-up of asset managers. Instead it is identifying crying needs from clients and then fulfilling those needs with strategic purchases like these.

Fresh off a home-run success in acquiring Windhaven as an RIA custody client, Charles Schwab & Co. is taking a page from its own playbook in tackling a new deal.

The big broker dealer has acquired ThomasPartners — yet another RIA custody client — and will use its services to meet the needs of investors who want dividend income from an actively managed fund.

In the case of Windhaven, Schwab was looking for a manager that had a proven track record in tough markets and one that could give people a manged portfolio of ETFs. See: A look inside Schwab’s big deal with a small asset manager.

The San Francisco-based custodian announced Monday that it is paying $85 million in cash to buy the $2.3 billion Wellesley, Mass. income-focused asset manager. Schwab could end up paying more for the firm based on future growth in assets under management and the deal is expected to close by the end of this year.

No use for wholesalers

Industry leaders say that this deal puts Schwab in position to further control product to retail investors and RIAs alike. Schwab bought Windhaven, then called Windward Investment Management, in November 2010 for $150 million in cash and stock. As of Sept. 30, 2010, Windhaven managed $4.24 billion and that amount has swelled to $12.5 billion as of Sept. 30, 2012. See: Schwab closes the Windward Investment Management deal but relinquishes the brand.

While the bulk of the assets first came from retail clients, there has been an uptick of RIAs using the product.

Walt Bettinger: I'd say it's less the power of our marketing than the power to meet client needs.
Walt Bettinger: I’d say it’s less
the power of our marketing than
the power to meet client needs.

RIA feathers shouldn’t be ruffled much by this move, according to Roger Hewins, a president of Hewins Financial Advisors, LLC, a San Mateo, Calif.-based RIA with more than $2.5 billion of assets. In the past Hewins has spoken out about how Windhaven appears to compete with advisory firms like his own.

“RIAs like us are choosers of investments for our clients,” Hewins says. “We have no use for wholesalers or promotions. We are doing our own research and relying on institutional quality resources like Callan Associates Inc. and Dimensional Fund Advisors. This is a different universe altogether.”

Still, he sees the move as a case of Schwab flexing its marketing muscles. “Schwab has the distribution and they’re looking for product,” he says. “Why limit yourself to getting paid for distributing when you can buy the producers and market the heck out of the product.”

The Charles Schwab Corp. CEO Bettinger said during an interview at the Tiburon CEO Summit yesterday that his company isn’t making acquisitions of asset managers simply based on its ability to drive greater distribution.

ThomasPartners is about to shed its single-placard image.
ThomasPartners is about to shed its
single-placard image.

“I’d say it’s less the power of our marketing than the power to meet client needs…we had more and more requests from clients for income generation.”

Hewins sees it this way:

“Schwab is fleshing out its retail offer in the wrap account business with interesting small money managers that they can scale up quickly with lots of promotion down their huge distribution channel.”

Stars aligned

As part of the deal, Gregory Thomas , CEO and chairman of ThomasPartners, and his investment team led by chief operating officer and chief investment officer William McMahon, will remain with the firm to oversee investment processes. Thomas earned his undergraduate degree at Yale University and an MBA from the University of Chicago.

The firm’s money management products will be available at a lower cost to RIAs through the Schwab Advisor Services platform. Once this deal is closed, ThomasPartners will no longer directly market to individual investors.

Gregory Thomas: Schwab's large national footprint, wonderful reputation and growing client base will enable us to reach a vastly larger potential pool of investors.
Gregory Thomas: Schwab’s large national footprint,
wonderful reputation and growing client base
will enable us to reach a
vastly larger potential pool of investors.

(Schwab has yet to determine the exact prices it will charge through RIAs, Clark says.)

“We have worked together with Schwab since 2001, with more than half our assets currently in custody on the Schwab Advisor Services platform, and we are excited to be joining such a great company,” says Thomas in a statement. “We believe the stars are aligned for a growing demand for the kind of money management approach we deliver and Schwab’s large national footprint, wonderful reputation and growing client base will enable us to reach a vastly larger potential pool of investors.”

According to Cerulli Associates, assets in separately managed account programs grew at a compound annual growth rate of 12.0% from 1999 to 2011 versus 4.6% for long-term securities. It is expected to grow at a compound growth rate of14% from 2011 to 2015.

Windhaven success

Industry leaders say that Schwab’s success with Windhaven was clearly a driver in this deal. See: Schwab adds $2 billion of assets from Windhaven, with RIA help, and another $2 billion of assets from 41 new RIAs.

“Schwab’s distribution power and Windhaven’s strong track record created an excellent environment to fully realize synergies from the vertical integration aspect of that deal,” says Daniel Seivert, CEO and managing partner of ECHELON Partners in Manhattan Beach Calif.

“It is natural for acquirers of asset managers to do all they can to drive more assets to the firm’s they buy…Schwab’s aspirations are likely the same in this instance.” See: Schwab adds $2 billion of assets from Windhaven, with RIA help, and another $2 billion of assets from 41 new RIAs.

Bernie Clark, head of Schwab’s RIA custody business, said in an interview at yesterday’s Tiburon CEO Summit that Windhaven’s success is certainly notable entering into this new deal.

“Windhaven’s doing really, really well. The growth’s been phenomenal. The return has more than justified the investment and I’m sure we’ll see the same with ThomasPartners.”

Gaston Ceron: You want solutions in-house that are somewhat differentiated.
Gaston Ceron: You want solutions in-house
that are somewhat differentiated.

Bettinger says that Schwab is working to add to its success in launching a dividend ETF but that it didn’t make everyone happy.

“Some investors want a more active approach,” he says. Bettinger also notes that Schwab is not a neophyte in owning managers considering all the funds owned through Charles Schwab Investment Management, which holds about $200 billion of assets. See: Schwab turns the YieldPlus page the old-fashioned way — with a whole new CSIM team.

Attract and retain

Industry leaders say that Schwab’s decision to buy this asset manager puts the company in a good position to generate additional revenues given the problems in the market like low interest rate environment.

“Transaction volumes are generally challenged and interest income is also challenge, I think this is another example of a good company like Schwab looking for an additional way to attract and retain clients,” says Gaston Ceron, an equity analyst with Chicago-based Morningstar Inc.

Seivert says the deal also represents a good use of cash by Schwab.

Schwab is poised to generate $1 billion in net income in 2012 but has more than $8 billion of cash on its balance sheet, Seivert says. He points out that Schwab executives were eying ways to put this cash to work for shareholders and likely considered a number of options including a stock buyback program, issuing dividends, investing in organic growth or growing through acquisitions.

In this case, the custodian pursued this asset management firm because it assigned with Schwab’s value proposition to its customers.

Dan Seivert: Acquisition of asset management firms and technology firms have a higher strategic benefit than acquisitions of banks, insurance companies, or securities firms given Schwab's product and target markets.
Dan Seivert: Acquisition of asset management
firms and technology firms have a
higher strategic benefit than acquisitions of
banks, insurance companies, or securities firms
given Schwab’s product and target markets.

“Acquisition of asset management firms and technology firms have a higher strategic benefit than acquisitions of banks, insurance companies, or securities firms given Schwab’s product and target markets,” Seivert says.

RIAs angry?

But while the move will certainly help the firm, industry leaders question whether it could alienate its army of RIAs because the firm is clearly ramping up its advice-driven products with this new lineup.

“This is another move Schwab’s making to swim further into advice selection,” Ceron says “All of these firms are looking for ways to retain their retail clients that are interested in advice offerings. Schwab sees that people do need advice. This purchase fits in with their need to find advice products to help them attract and retain clients at a time when other revenue lines are pretty challenged.”

Roger Hewins: This fund looks pretty blue blood/blue chip dividend and is basically a value manager. This is not going to blow up
Roger Hewins: This fund looks pretty
blue blood/blue chip dividend and is
basically a value manager. This is
not going to blow up

Ceron says he wouldn’t be surprised if some RIAs do consider this a conflict. “You might have some conflict,” he says. “But you want solutions in-house that are somewhat differentiated. It’s investable when you have in-house offerings and RIAs that there will be some tensions between them. The key is to find ways to manage tensions such as managing the referral process and make sure the in-house advice model is different from RIAs.”

Clark says thus far he has not had to handle any RIA complaints about the deal.

Seivert points out it’s only natural for advisors to analyze whether there is an issue related to Schwab’s objectivity in the area of manager selection.

“Having Thomas Partners as an option on a platform is usually not much of an issue,” he says. “To the extent Thomas’s products are recommended or preferred by Schwab; advisors will naturally want to ensure such evaluations were performed with objectivity and consistent rigor.” See: Windhaven misses its 12-month benchmarks again but still hits asset-gathering mark.

Won’t blow up

Even though, he doesn’t intend to use the funds, Hewins says the key to this deal is the product is more conservative and “should not blow up like a bad hedge fund or the yield plus fund.”

“This fund looks pretty blue blood/blue chip dividend and is basically a value manager. This is not going to blow up,” Hewins says