A New Rule Is Reshuffling The Financial Services Industry

Adam Fischbaum's picture

Friday, December 16, 2016 - 11:30am

by Adam Fischbaum

In a recent article, I discussed how to profit from an "Uber Moment", referencing the wildly successful and revolutionary ridesharing app that has changed the transportation industry. Most industries are currently experiencing some sort of significant cultural or technological upheaval, an "Uber moment," that will rapidly transform how they do business. And nowhere is that more apparent than in an industry that I know intimately, the financial advice business.

Historically dominated by large brokerage firms, the business of providing financial and investment advice and accompanying products to individuals has seen constant evolution in recent years. The rise of discount brokerage houses, internet-enabled stock trading, and financial deregulation has enabled many other financial intermediaries to scramble after a slice of the pie. However, while these changes have shaped the business significantly over the past 30 years or so, no single moment has had a bigger impact than the forthcoming Department of Labor Fiduciary Rule.

Issued by the DOL in April of this year, the rule sets guidelines for financial services firms in providing advice and products related to client retirement accounts. Put simply, financial intermediaries must act in their clients' best interest when managing retirement money. The catalyst for this rule evolved, mainly, from the experience of investors who spent their working years contributing to a low cost 401(k) plan only to rollover their savings upon retirement to higher-cost, full-service financial advisors. Fair and full disclosure: I am one of those advisors.

While I could argue the merits or the absurdities of the DOL rule, it's the law of land and just about every financial services firm involved in the advice and investment product business is scrambling to comply. Bank of America's (NYSE: BAC) Merrill Lynch brokerage arm has prohibited its financial advisors from charging traditional, transactional commissions in any retirement account (IRA, Roth, etc.). As the biggest brokerage firm on the street, Merrill's action is indicative of the Uber Moment nature of the DOL rule.

So how can investors profit? Based on my research, here are two strong ideas.

Toronto Dominion Bank (NYSE: TD)
How can a Canadian bank benefit from American financial regulation? By being the largest shareholder of one of the largest online brokerages in the U.S. Primarily an online entity, its 40% ownership in TD Ameritrade (NYSE: AMTD) sets them up for success going forward in the post-DOL environment.

TD Ameritrade is one of the biggest institutional providers of services such as asset custody and trading platform to registered investment advisors (RIAs). The financial advice industry has seen a rise in financial advisors leaving the big firm world and taking their practices down this route. In charging an asset management fee as opposed to transactional commissions, RIAs are in compliance with the new DOL rule.

With rapid and repeated revenue squeezing at large firms like Merrill, I expect that many traditional advisors to go the RIA route. Look for AMTD's contribution to TD's non-interest revenue, which clocked in at over $11 billion in 2015, to grow with this shift.

But why shares of TD rather than AMTD? TD's yield and valuation metrics are much more attractive. TD's 2016 earnings per share (EPS) are expected to come in at $4.44, a 5% bump over 2015's EPS of $4.23. Shares currently trade near $50 with a forward P/E of 12.8 and an annual dividend yield of almost 3.3%.

Invesco Ltd (NYSE: IVZ)
Historically, Invesco has been a major player in the advisor-sold mutual fund and separately managed account space. But with the rise of exchange traded funds (ETFs), the firm has jumped into fray big-time.

With over 140 ETFs covering domestic and international asset classes, Invesco's PowerShares Capital Management arm has amassed assets under management of over $95 billion, according to company data. Because of their relatively low internal expenses, ETFs are well-suited for advisor use under the new DOL rule.

Per Reuters, the U.S. ETF market is worth well over $2 trillion. Currently, Invesco's PowerShares holds the number four spot with the top three belonging to Vanguard, Blackrock (NYSE: BLK), and State Street (NYSE: STT). And while ETFs are definitely a growth driver, there's still plenty of value in Invesco's core money management business.

Revenue has grown at a consistent 5% average annual rate over the last five years (not bad in the stagnant financial services space) with EPS growing at 10% average annual rate for the same period. The company has grown the dividend by 13% annually as well. Shares are currently priced close to $32 with a 14.2 forward P/E and a 3.5% dividend yield.

Risks To Consider: There's still a great deal of uncertainty concerning the DOL law's final form and implementation. The vocal, deregulatory tone of the incoming Trump administration may determine the final outcome. Therefore, the rush to change may be slower than initially expected. While these two companies are positioned to benefit post-DOL rule, they also provide investors the added diversification of other business lines to contribute to earnings and cash flow. Both are hardly one-trick ponies.

Action To Take: While the financial services industry has endured many rapid changes driven by market conditions, technology, and regulations, the coming DOL rule seems to be one of the most fundamentally disruptive shifts in recent history. Both TD and IVZ are well-positioned to benefit from product and worker shifts in the industry. Both stocks are reasonably valued compared to the overall market and provide an attractive income stream to supplement growth.

Editor's Note: StreetAuthority's experts have pinpointed over two dozen game-changing tech stocks in the last few years -- but this year's "Virtual Reality Revolution" is set to break all our past records... But first you have to know how to play it...

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.