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How to choose a stock broker

Created:

23 April 2008

Written by:

Faith Glasgow

As investor confidence and markets alike continued on the whole to strengthen, 2006 was a brisk and bountiful year for the stockbroking industry as a whole. However, according to the recently published In-Depth Review of Stockbrokers from stockbroking analyst Compeer, it's the execution-only sector that has shone most brightly over the past 18 months.

During the loss-making years of the bear market, the execution-only firms were busy cost-cutting, slashing their prices, consolidating and restructuring in a big way. In the words of the Compeer report: "Fundamentally reengineering their business and their service offering".

That overhaul has finally started to pay dividends and execution-only brokers are finally making a profit. But while they're attracting new clients, it's not their traditional market of UK equities that have seen most of the expansion in business. The sector has successfully diversified over the past few years into new instruments and account types, and it's here that growth has been concentrated.

In particular, execution-only clients have tapped into contracts for difference (CFDs) - 2006 trading volumes were up by a third on 2005 - spread betting and collective funds. In addition, a lot of extra business has been generated through tax wrappers such as self-invested personal pensions (Sipps), individual savings accounts (Isas) and Child Trust Funds. Execution-only brokers saw an increase of 46 per cent in Sipp investments in 2006, while self-select Isa volumes were up 20 per cent.

Interestingly, according to Compeer's report, it seems that even the wealthiest investors are increasingly homing in on the low costs and online convenience of execution-only services, as well as the growing range of products available: the number of execution-only dealing accounts worth over £1m increased fivefold in 2006.

EXECUTION-ONLY COSTS

As part of the re-engineering process, dealing costs have continued to come down in the face of continuing stiff competition, especially online. Two or three years ago, flat fee commissions under £10 leapt out of the page as bargains; now, as our best buys box shows (see below), it's possible to pay as little as £8, even for a one-off trade, while frequent traders can pay as little as £6.

The cheapest way to buy is through the low-cost regular savings plans offered by Halifax, The Share Centre and Interactive Investor, although you must be prepared to forego the immediacy of real-time dealing and have your money invested in weekly batches alongside the money of other investors. For the rest of 2007, you could buy shares through Halifax's ShareBuilder scheme without paying any commission at all - the company has done away with the usual £1.50 charge per trade for that period.

Transaction charges imposed by the stock exchanges account for most of the costs faced by brokers (and so those passed on to consumers). These are being eroded through competition, which has led some commentators to speculate about the possibility that the UK could be moving towards an American exchange model, with charges for booking a trade as low as £1-£2, rather than £5-£6.

But, according to the Compeer report: "There is a general feeling in the industry that commissions are pretty much as low as they can go, and there will be less direct competition on price [rather than more]."

Whatever happens to dealing costs, it's important when you select a broker to keep a sharp eye out for additional charges - both per-bargain extras such as compliance charges, and monthly or quarterly account fees - and build them into any assessment of dealing costs. For example, Jarvis offers the lowest online commissions of all, at £5.95 - but that's bumped up by quite a hefty £10 monthly fee which means in effect that you have to deal at least five times a month to bring your unit cost down to below the flat £8 per deal offered by Hoodless Brennan.

ONLINE

Online business continues to grow faster than telephone business - in fact, the Compeer report shows that the volume of execution-only trades conducted online was up 20 per cent in 2006, while offline volumes barely increased at all. Around 60 per cent of execution-only trades were made online.

At Barclays Stockbrokers, the largest execution-only broker in the UK (accounting for up to a quarter of retail trades on the London Stock Exchange on a typical day), that figure is considerably higher. Brokerage director Phil Northey says that 87 per cent of the firm's trading is now done online - and that the biggest factor in this shift to the internet is the exponential growth of broadband in private homes.

Mr Northey believes that, as a consequence of the speed and ease of online dealing, as well as the cheapness of online services, individual traders are changing in their attitudes. "They are wanting to make their own decisions, and they're increasingly active - even steady, long-term investors are regularly revisiting their portfolios now," he says.

By contrast, the Compeer report finds that most execution-only traders are still essentially 'buy-and-hold' investors, and suggests that future business growth for execution-only brokers is likely to come from "less active traders looking for a long-term home with appropriate tax wrappers for their investments".

So what constitutes an 'active' trader? How often do they deal? Compeer defines active traders as those who trade more than 30 times in a quarter. Mr Northey categorises those trading 30 times a quarter as "fairly active" but says that the most active clients trade around 80 times a quarter - or about once a day.

The importance of frequent traders, and the desire among brokers to encourage more such clients, is underscored by an interesting development evident in this year's Investors Chronicle stockbrokers survey. On the whole, the commission cuts that have occurred over the course of this year have focused mainly on frequent trader discounts, rather than on charges for single trades. Hoodless Brennan has gone so far as to put up its online prices for one-off bargains from £7 to £8, keeping the discounted £7 and £6.50 deals for clients trading more than 10 and 20 times a quarter, respectively.

And it seems that a number of firms have re-examined their definition of 'frequent trader', and have reduced their thresholds so that a lot more clients trading maybe six or seven times a quarter can benefit from substantial discounts in dealing costs.

Barclays itself is a good example: last year's survey shows that its £7.50 frequent trader tariff kicked in after 10 deals per quarter, but it has reduced the threshold to five deals a quarter, with a further reduction to £6.95 for those trading more than 10 times a quarter.

Other firms that have either introduced a frequent trader discount or reduced the trading requirements for it include Lloyds TSB, with an £11.50 discounted rate after 12 deals per quarter, Saga Share Direct, which has brought in a lower commission of £9.75 after the first six deals per quarter, and Selftrade, which more than halves its commission to just £6 for those who manage to clock up 100 trades a quarter.

ADVISORY/DISCRETIONARY

If you want someone else to take the strain, making investment decisions according to an agreed mandate and generally running your investment portfolio for you, a discretionary service is the way forward; if you want someone else to run your money but give you the final say in any decision to buy or sell, you need an advisory portfolio manager.

However, discretionary fund managers, able to take decisions and act on behalf of clients without consulting them first, have found it easier to hold their own against the strengthening execution-only sector than have advisory managers.

As the Compeer report explains: "With the increased cost and risk of servicing from a compliance perspective, [advisory business] is a less attractive model. Firms have also had difficulty in generating stable revenue streams from such commission-driven business with clients reluctant to trade actively in the market.”

Although our survey shows that advisory options are still much in evidence, it's certainly also true that several portfolio managers, including Fiske and Gerrard (now part of Barclays), have stopped offering an advisory service. Others, such as Rathbone and Rensburg Sheppards, make no differentiation between the charges for advisory and discretionary - although Andrew Bell of Rensburg Sheppards makes it clear that the firm's preference is for discretionary business.

Mr Bell also identifies a shift towards fee-based arrangements: "It's not 100 per cent, but brokers used to be purely transactionally driven. Increasingly, private-client stockbrokers have moved towards a mix of fees and commissions and transaction costs," he explains.

Some give clients the choice of a fee-only discretionary service or one based on a smaller fee plus dealing commission - Rensburg Sheppards is one such, and Taylor Young is another. But Compeer stresses that generally, "commissions remain a key source of revenue".

Compeer's assessment of the full-service sector reflects the fact that there's a great deal of change going on in this part of the industry, and the firms that are thriving are those moving with the times. They're doing this in various ways - by acquiring other investment firms, offering a wider investment choice including collectives and alternatives such as hedge funds, placing an increasing emphasis on broader financial planning for clients, and/or targeting the younger generation as it moves up the wealth scale.

"There's an increasing appetite across the board for alternative assets to be included as part of a portfolio-management package," says Mr Bell. "Partly that's a result of effective marketing; partly it's a reflection of people's greater caution in relation to the equity markets. But it's important that clients get genuine added value and diversification from a broader mix. Most are mystified by the amount of investment choice now available; they do need advice, and firms like ours have to do it properly"

We have not attempted to draw any price-based conclusions about portfolio-management services in our best buy box (see below), because services and products in this sector can vary so widely, and because they tend to be much more 'relationship'-oriented. You're also paying for investment advice and/or performance - and in many cases a more inclusive approach to your financial affairs generally - as well as for the basic issue of access to the markets, so it really is difficult to make useful comparisons.

Perhaps the main thing to be aware of is that some firms are much more accessible to investors with smaller portfolios, although typically they will offer management via a selection of collective funds, rather than individual equities and other investments. Such a solution provides greater diversification and a more cost-effective investment for smaller investors. The minimum entry level shown on the portfolio management tables gives some indication of where the service is pitched.

CHOOSING AN EXECUTION-ONLY BROKER

■ Do you want to be able to deal by phone as well as online without worrying about price differentials? Look at Interactive Investor, Midas, Selftrade or the Share Centre, all of which charge the same for both online and telephone dealing.

■ Do you want certificated trading? Few brokers offer this option online - Abbey, RedM and TD Waterhouse being three that do - and only Interactive Investor makes no additional charge. Offline, the choice is considerably wider and includes several firms making no additional charge - but many do charge extra, so be careful if you want to trade regularly this way.

■ Do you want to explore alternative trading opportunities such as CFDs? Some brokers such as E*trade and Direct Sharedeal offer an exceptionally wide range. Others, such as Fidelity, have a pretty limited choice.

■ Do you want to run your own Sipp account? Not all brokers offer a Sipp wrapper; look also at the wrapper cost as these can vary considerably.

■ If you want online tools and research from your broker (even if you don't trade online), have a thorough look at the websites before you commit yourself. Some, including Barclays, Hargreaves Lansdown, TD Waterhouse and Selftrade, sell their execution-only service on the back of a comprehensive research facility.

■ Limit orders and stop-losses have been much used by traders in the volatile markets of recent months. Limit orders in particular are widely available, but some firms only offer them 'good for the day' or at their discretion.

■ Do you want an international service? Make sure you can access the markets you're interested in - and watch out for overseas transaction costs.

■ Do you want to be able to sound your broker out with ideas and get recommendations from him? Dealing with advice is widely available but, apart from The Share Centre's free advice phoneline, which is available on its £7.50 fixed fee tariff as well as on its variable percentage tariff, you will not find low flat fee charging structures. Our best buy box (see below) highlights some of the best-value services.

Click on the links below to download PDF versions of the Stockbrokers' Survey:

• Stockbrokers - Online

• Stockbrokers - Execution only by phone or post

• Stockbrokers - International

• Stockbrokers - Dealing with advice

• Stockbrokers - Portfolio management

• Stockbrokers - Nominees

Note: If you do not have Acrobat Reader, you can download it at www.adobe.com/uk)

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