Chapter 9
Working with Brokers
IN THIS CHAPTER
Recognising what a stockbroker can do for you
Taking advantage of full-service or investing in cyberspace
Paying the broker to work for you
Establishing the right broker–client relationship
Brokers seem always to get pretty bad press. Their huge salaries and flashy Porsches, combined with the latest float fiasco and discredited recommendations, have lowered their standing in the investor community. Following the 2000 tech stock crash, and again following the global financial crisis of 2008 to 2009, a facetious definition of broker was ‘poorer than you were last year’.
But no matter how much you may complain about stockbrokers, as an investor, you can’t do without them. Stockbrokers are an essential part of the investment process because in most cases you can’t buy or sell shares without using a broker. Only a qualified broker can place your order to buy or sell shares via the Australian Securities Exchange (ASX) system. However, this ‘broker’ could just be an online broker’s interface to the ASX on your computer screen.
In this chapter, I show you how to deal with brokers effectively. Finding a broker isn’t difficult, but you need to know what brokers do and how they do it before you make your choice.
What a Broker Does
A stockbroker is licensed by the Australian Securities and Investments Commission (ASIC) to offer investment advice; a stockbroker also works for a firm that’s licensed by the ASX to trade in the sharemarket. The sharemarket is a public marketplace, but only stockbrokers can place orders.
Shares can be transferred outside the market without involving a stockbroker, but the shareholder has to find the other party to the transaction and settle on a price. Shares can also be transferred privately without any payment; for example, you can transfer shares between family members. In all off-market transfers, a standard transfer form must be used to advise the company’s share registry. The transferor and the transferee must sign this form. Off-market transfers don’t require a broker because technically the shares aren’t going through the physical market.
A broker acts as your agent, buying or selling shares on your instructions. Stockbrokers charge a fee for this — called brokerage — and they may also offer other services, such as advice on which shares to buy or sell, portfolio management and financial planning.
In Australia, 60 broking firms (called ASX market participants) are active, including Australian branches of global investment companies, such as UBS, JP Morgan, Goldman Sachs and Morgan Stanley, as well as full-service local firms, such as Macquarie Equities, Morgans, EL & C Baillieu, Bell Potter, JB Were, Shaw and Partners, Taylor Collison, Phillip Capital, Evans and Partners and Hartleys.
More than 20 of the broking firms are online brokerages, led by CommSec, Bell Direct, IG Share Trading, CMC Markets, nabtrade, ANZ Share Investing, Macquarie Online Trading, Westpac Online Investing, Saxo Capital Markets, Amscot, FP Capital Markets, HSBC Online Share Trading and Interactive Brokers.
Many of the large investment bank–owned brokerages deal solely with the ‘institutional’ investors (managed funds, superannuation funds and insurance companies) that own most of the sharemarket. You probably won’t deal with this kind of heavy-duty broker; fortunately, the kind of broker that you deal with probably needs you more than you need them.
Stockbroking for Everyone
Stockbroking was once a sellers’ market. Stockbrokers held the monopoly on transactions in securities listed on the stock exchange and brokerage rates were fixed. If you wanted to buy shares, you had to use a broker. They knew you needed them, and if they didn’t like you as a potential customer, you were locked out of the sharemarket. You could go to smaller firms, but if your investment was too small the broker would tell you to use a managed fund. Indirect share ownership was the best you could hope for.
In the past, stockbroking firms charged high prices to cover their transactions as well as their other costs, including opulent offices, well-paid research analysts and client advisers, client newsletters, and a labour-intensive back-office shuffling of the firm’s paper. A brokerage rate of 2 to 3 per cent of the value of a transaction was considered justifiable.
That scenario is no longer true. Although stockbrokers still hold the monopoly on transactions, the difference is that, since 1984, they’ve been free to price their charges according to the service offered. Today, you can choose among full-service and execution-only (or discount) brokers, who mostly conduct their business online.
Buying full-service
Full-service brokers offer their clients the whole traditional kit and caboodle — advice on shares to buy and (much rarer) sell, research reports, client newsletters, access to floats, portfolio management and financial planning. Full-service brokers also know how to charge for their services. (Refer to Chapter 6 for a rundown of typical costs for full-service brokers.)
It’s fair to say that under the attack of online broking, full-service broking has evolved away from transactional, commission-driven sales to remuneration based on a percentage of assets held in portfolios that are managed for the long term. Essentially, which type of broking suits best depends on the client. The benefits of a full-service broker may be worth the cost. Such brokers offer you research and advice on stocks and other investments and, potentially, access to upcoming floats. Brokerage fees are usually negotiable with advisory brokers; if you’re trading frequently enough, you can probably negotiate a better rate.
Many full-service brokers have diversified to become wealth managers, bringing in expertise in superannuation, insurance, taxation, retirement planning and estate (wills and inheritance) planning. They may offer discretionary services, where they manage portfolios and make investment decisions for their clients. The full-service menu may include access to international shares, alternative investments, credit products, 24-hour futures and foreign exchange. The fee will reflect the meal of services the client chooses from the menu.
Increasingly, many full-service brokers are trying to move upscale to specialise in ‘sophisticated’ and ‘wholesale’ investors who are eligible for investment opportunities at an institutional level.
The Corporations Act 2001 permits offers of securities to be made to persons defined as ‘sophisticated investors’ without a disclosure document, meaning that these people get access to investment opportunities that run-of-the-mill retail investors do not get.
The ‘sophisticated investor’ criteria are either:
- Net assets of at least $2.5 million (including the net assets of a company or trust controlled by the person)
- A gross income (including the income from a company or trust controlled by the person) of at least $250,000 a year for each of the two previous financial years
The category of ‘wholesale’ investor is also used, defined as someone able to invest more than $500,000 in any security or product.
The rise of online broking has not killed off full-service broking; far from it. If you have a client adviser who’s helpful, courteous, interested in you and how your financial knowledge develops, and who becomes a trusted confidant, you’re in good shape. If you’re happy with the firm’s research, recommendations, newsletter and other services, excellent. Any investor in this position would consider the increased cost of the service cheap. Many investors have the same adviser for years and stick with them as the adviser moves on to different firms.
Going online – or on the phone
Online broking certainly democratised access to the market, and smartphones took this to a whole new level. All of the online brokers have apps that allow trades to be completed on a mobile phone or tablet — and portfolios, charts, research and lots else to be viewed. You can buy a parcel of shares while you’re sitting on the bus and sell them while jogging at lunchtime. It’s great that people have this ready access to the sharemarket.
Online broking certainly suits self-reliant investors, but not every-one can be that. Plenty of investors welcome the help of their stockbroker. Not all investors want to follow the market closely or trade frequently. Some are more interested in a very strategic approach to long-term investment.
Most online brokers offer straight-through processing, which means that trades are fully automated — you’re trading directly into the market yourself. But the brokers also have filters, and if an order looks like an error (for example, it’s too far away from the last trade of the stock) or possible market manipulation, it won’t be lodged and you’ll be asked to check it.
The 42 trading platforms offered by the 20 online brokers give investors open, cheap access to the market, for as little as $6 a trade (for amounts up to $1,000). As of 2019, online brokers accounted for about 12 per cent of all ASX trades. Effectively, that represents more than 70 per cent of retail trading. The average trade size on the online market is $19,000, and this is increasing all the time.
CommSec controls about half of the online share-trading market in Australia, while ANZ Share Investing (the former E*Trade) controls about 20 per cent. Westpac Online Investing and nabtrade each hold about 10 per cent.
Online broking allows self-directed investors to have total control over their investment strategy. People now have on their desks, tablets and smartphones the trading capability that an institution would have had ten years ago. Such investors can trade online as much as they like. They can look at where the market is, look at the buy and sell orders in the market, look at the trend of the market that day, place their order, and instantly see what it went for.
Some online brokers have expanded beyond simply offering cheaper transactions, increasing their offering to include extensive research, recommendations, information, software, charting and analytical tools. Some offer ‘model portfolios’ provided by third-party research houses. These model portfolios are selected to complement a client’s individual requirements, investment time horizon and appetite for risk.
Online brokers offer different product features to different sectors of the market. For example, customers new to online broking are provided with fundamental and economic research, educational material and portfolio management tools, while active traders — those who meet a minimum level of activity — are offered features such as dynamically updated data, price alerts, upgraded charting packages and the ability to make conditional (or ‘stop-loss’) orders for free. Customers also have access to tax reporting tools.
Different customers may also have different data requirements. Your data needs largely depend on how frequently you intend to buy and sell. You can access three types of data delivery:
- Delayed, where the data you see is 20 minutes old
- Live, where you click to refresh your browser for market updates
- Dynamic, where the data is streamed live from the market
It may not be necessary for an active investor to pay for dynamic data. Whether you choose to depends on whether you need to react to changes within minutes, over the course of a day, or over a week.
So much functionality is offered in terms of education, information, research and charting that the online brokers have moved well beyond their ‘execution-only’ beginnings. They may not give direct advice, but they certainly give self-reliant investors the tools and the knowledge base that they need to make more informed decisions.
While online brokers don’t give advice, they do try to give their customers access to as much information and insight as possible. They help their clients to make better investment decisions by offering educational content that’s relevant to first-time investors, economic and company research, news feeds, relevant and timely market information, and scanning and number-crunching tools. Online traders want fundamental and technical research available at the click of a mouse; they want to be able to put in the parameters, filters and indicators that they feel are important to their trading decisions. They want to set stop-losses or ‘stop-profit’ orders — either on price or percentage moves — so that they can control their entry and exit strategy. These days, online brokers offer these options, seeing themselves as one-stop-shops for investment, wealth creation and trading — providing everything short of actual advice.
Online brokers are well represented on social media, with some hosting online ‘communities’, where clients can exchange ideas, post real-time news, speak to the firm’s analysts, or talk to the firm’s trading services team if they have any issues with the trading platform or their account. Some (for example, eToro) offer copy trading, a form of trading that allows would-be traders to follow and copy automatically the positions opened and managed by selected expert investors, usually through a ‘social trading’ network.
Investors need to work out what kind of investor they are before they decide which medium — online or full-service — to use.
Choosing the Best Broker for You
To choose the kind of broking service that best meets your needs, you need to answer the following questions:
- How much are you prepared to pay?
- How many trades are you likely to make?
- What services do you need?
If you’re new to the sharemarket, and you’re investing a relatively large amount of money and want to establish a well-diversified portfolio designed for patient capital appreciation, you can benefit from a consultation with a full-service broker. If you know the sharemarket well and want to use your knowledge to trade your portfolio, you can opt for an online broker.
You don’t have to confine your trading activity to one or even two brokers. By all means spread your activity around. If you want to participate in floats, opening and maintaining an account at one of the larger retail brokers makes sense. Large retail brokers have access to the big company floats. The more transactions you put through this firm, the better your chances of getting in on the float action.
Cheaper brokerage means less service, which can lead to poor purchases. If you save 1 per cent in brokerage fees but pay an exorbitant price for the shares, you haven’t achieved a saving. You need to know what you want from a broker before making your choice.
Fighting for full-service
After several years of copping the online assault, full-service brokers made a comeback through one of their trump cards — access to floats. The stockbroking industry earns 90 per cent of its revenue from 10 per cent of its clients — that’s why full-service brokers get first crack at the floats. A stockbroking firm handling a sought-after float is under no obligation to offer the shares to the wider public, unless the floated company so requests. Most floats are small enough to be handled comfortably by the large full-service brokers.
However, online brokers have built up the distribution ability to challenge for the large floats; after all, CommSec’s 1.1 million customers is a pool of potential investors that is very hard to ignore!
Usually, brokers fill float issues from their own client base first. If the brokers know they can achieve this without help from another firm, only their clients receive an offer of shares. That’s why many online clients also work with a full-service broker, although larger floats increasingly use the online brokers as a distribution tool.
Doing the research
Research analysts from stockbroking firms produce a huge amount of information. Their newsletters contain a good deal of research for private clients, but this is only a fraction of the pixel (and paper!) mountain of analysis sent to institutions. Since the Australian market is one of the most concentrated in the world, the top 50 companies are the most scrutinised and researched. Stocks that aren’t large enough for the S&P/ASX 200 index are less likely to be researched.
The bulk of the research produced is aimed at the institutional buyer. This information can be a problem for the investor who’s receiving recycled institutional research, laden with jargon, diagrams and acronyms. What your full-service broker should be doing is advising you when to buy and sell shares.
Unfortunately, brokers rarely tell you when to sell — unless you’re one of their best clients, brokers prefer to offer buy recommendations. Only people who already own shares can act on sell recommendations.
Companies don’t like to see their shares rated as a ‘sell’ since they never think they deserve it. In the best broker–client relationship, for example, your broker may recommend selling a particular stock at $5 and buying back in at $4, not because she hates the company, but because her research has shown that at $5, the stock has gone past fair value.
Paying for service
Let’s face it, the reason full-service brokers aren’t cheap is because they don’t want small clients who generate only a small amount of brokerage. They’d rather let small clients go to online brokers.
If you buy $1,000 worth of shares through a full-service broker who charges a minimum brokerage of $80, the brokerage on your purchase is 8 per cent of the total. The share has to rise by more than 8 per cent before you’re ahead. The same investment can be made through an online broker for as little as $6.00. According to research house Canstar, in 2020 the average brokerage on a $1,000 share purchase through an online broker was $16.70, while for a $10,000 share buy, the average brokerage was $18.66.
If you’re a longstanding or highly active client, you’re probably able to negotiate a discount, but if price is your only criterion, clearly you’d be mad to go through a full-service broker. But the story is different if your relationship with the full-service broker is a good one — if you get sound personalised service and good long-term strategic advice, this relationship can pay for itself many times over.
Interviewing for a Broker
Always remember — stockbrokers need you more than you need them. The market today is a buyers’ market for stockbroking services, particularly if your stockbroker thinks you may defect to an online broker.
A full-service firm assigns an adviser, who asks you how much you have to invest. For a full-service broker, an investment less than $10,000 wouldn’t be considered worthwhile. For that amount of money, the broker may argue that achieving proper diversification is difficult and that you’re better off with the in-built diversification of an ETF or managed fund. (Refer to Chapter 5 for an explanation of how ETFs and managed funds diversify.)
Although the ASX’s trading system could accommodate the purchase of one share in any company, the brokerage fee would likely be more than the cost of the share. If you pester a broker enough, they’ll buy or sell your small parcel — but expect to pay a hefty fee if it’s a troublesome transaction.
Your adviser establishes
- How comfortable you are with risk
- How well you understand the sharemarket
- Whether you want capital growth or income
- Whether you intend to invest in capital for the long term, or whether you want to trade shares
A good broker may tell you that your $10,000 would probably be better off in an ETF or managed fund rather than buying several shares; if one of the stocks purchased doesn’t work, the portfolio is in trouble. For the money invested, a managed fund makes more sense.
You don’t have to accept that advice, but you then have to do your own research and analysis to make your small portfolio work (refer to Chapters 7 and 8 for details on how to research companies).
If you decide to work with a full-service broker, be ready to ask the broker some questions, such as:
- Where do they invest?
- What sort of shares do they prefer?
- How many floats have they participated in? (Check this against a list of floats that have taken place over the same period.)
- Are they willing to have a two-way relationship? (Ideally, your adviser will be prepared to listen as well as talk.)
It’s not okay if your adviser patronises you or obviously fails to prepare for your consultations. Nor should you accept being badgered to buy or sell stocks. A broker’s income comes from commission on transactions. To make money, the broker must be raking in commissions. Repeat this mantra: ‘My broker needs transactions to make money. Ergo, he wants transactions to occur. Ergo, he is happiest when I am transacting.’ A broker’s business is a sales business. The best clients, who generate the most sales, receive the best service.
If your broker says a company looks good, ask why. Ask the broker for the price/earnings (P/E) ratio, the net asset value, the revenue and earnings track record over the past three years, the consensus forecasts for the next two years, and the proportion of its sales that go to export markets. Put pressure on your broker to provide factual substance to the recommendation, otherwise all you’re getting is a tip, and you can get enough of them at dinner parties.
Making the most of full-service
If you decide to take the full-service route, make sure that the broker earns their commission. When your broker commits to maintaining a properly structured investment portfolio, some essential steps must be taken. These steps should
- Determine your risk profile and the level of risk that you’re comfortable with that will meet your investment objectives
- Locate the investments that fit your risk profile and meet your investment objectives
- Monitor your investment portfolio and your financial situation
- Structure your financial affairs in the most tax-efficient manner, to maximise your potential to create wealth and minimise tax
In a full-service broker–client relationship, you pay for extra services that help to maximise your ability and opportunity to create wealth.
Forging a new relationship
Some brokers, notably the Australian arms of major US investment banks, have embraced a deliberate strategy of moving away from transaction-based commission revenue to an annual fee levied on assets under management. Under this model, called relationship management, the brokers manage the portfolio of their customers in return for annual fees. In this situation, the broker brings in the services of experts to take care of the client’s overall financial needs — in fields such as taxation, banking, property investment, derivatives and futures.
This approach is based on the 80:20 rule, which dictates that 20 per cent of the firm’s clients generate 80 per cent of its revenue. This rule is more like a 90:10 rule at the high end of stockbroking, and some firms allocate their resources to the most lucrative area — those with the most to invest. In other words, the firms cull their client list and encourage their advisers to build assets under management rather than generate trades.
Stockbroking is a buyers’ market and willing investors can easily find a firm happy to carry their business, although some clients may find it a wrench to leave an adviser they trust. Investors who prefer to conduct high-volume, low-cost business are not suited to relationship management; these investors find that an online execution-only broker is the best fit for their needs.
Using broker sponsorship
Shareholders can arrange to be sponsored by a broker in their dealings with the CHESS clearing house (refer to Chapter 6 for a full explanation of CHESS). It doesn’t cost anything, but a formal agreement is required. The shareholder is allocated a holder identification number (HIN) that covers the client’s shareholdings and acts as an identifying password into CHESS. Your HIN must be quoted when placing orders.
Alternatively, listed companies can sponsor their own shares. Shareholders electing to use this system are allocated a security holder reference number (SRN), which covers only the holding in that particular company. Issuer sponsorship is popular with shareholders who don’t want a formal relationship with a broking firm. With broker sponsorship, if you want to sell through another broker, you must first transfer your shares into the sponsorship of the other broker, which is unnecessary paperwork. Discount brokers also offer CHESS sponsorship facilities. Your account and paperwork are the same but you’re paying a lot less to trade.
Locating the ideal broker
You can try several effective ways to find a good full-service stockbroker. Word-of-mouth is a good starting point. If your friends are happy with their brokers, these brokers may be worth contacting; it helps if you can contact a broker armed with a referral from an existing client. The ASX also offers a referral service and its website (www.asx.com.au) lists all brokers’ contact details. Visit these brokers’ websites and assess their offering.
For online brokers, Canstar at www.canstar.com.au, Finder at www.finder.com.au and Mozo at www.mozo.com.au provide a summary of all online brokers’ fees and charges, and which services they offer.