Repeal of the Glass-Steagall Act has opened the competitive floodgates among the banking, brokerage, and insurance industries, sparking an age where products and services are up for grabs. The Gramm-Leach-Bliley act, which repealed the Depression-era Glass-Steagall, has also created some new products, with one of the first out of the box being FDIC-insured money market accounts.
These accounts, also called "bank savings alternatives" or "sweep accounts," are gaining popularity among consumers and are being offered by fund companies and wirehouses. Reserve Funds was first out of the gate in 1997 with its Reserve Insured Deposits, a product that it launched through its subsidiary, Reserve Management Corp., and that offers unlimited transactions. Next up was brokerage king Merrill Lynch with its Banking Advantage Program, which works as a default sweep from money market funds into its Cash Management Accounts. And this January, Salomon Smith Barney joined the pack with its Bank Deposit Program. Salomon, now a member of Citigroup, sweeps cash deposits into its interest-bearing, FDIC-insured money market accounts at up to six Citigroup-affiliated banks. TD Waterhouse's Bank Money Market Account has been around for a couple of years. And Charles Schwab himself hinted at the Investment Company Institute's (ICI) annual shindig earlier this year that his eponymous brokerage behemoth was mulling over FDIC-insured accounts.
To be sure, Merrill Lynch and other brokerage houses' moves to offer a bank savings alternative isn't solely an attempt to provide clients with an added product. It's also a ploy to pull in those checking and savings accounts that have been out of their reach. It's apparent that brokerage firms and wirehouses are taking a holistic view of wealthy Americans' financial needs and adopting a panoply of services to accommodate them.
Advisors may not view FDIC-insured accounts as the hottest ticket in town, but having these bank savings alternatives on hand could offer a competitive boost. "Advisors have to be aware of the trend of bank savings alternatives because their customers may start asking for it," says Peter Crane, managing editor of iMoneyNet, Inc.
The June issue of Money Market Insight, published by iMoneyNet, Inc., says growth in FDIC-insured money market accounts are threatening to overtake that of retail money market funds.
While advisors may want to get their hands on these bank savings alternatives to stay competitive, some advisors are feeling stymied by a poor choice in money market funds that are offered through wirehouse platforms. Most custodians only allow advisors to use the house money funds, where the choice usually varies from six to eight funds. Advisors are limited to custodians' money funds because the custodian is able to earn 50, 60, or 70 basis points on them. "Their [money market] funds are profitable ventures for them," says Lewis Altfest, with L.J. Altfest & Company, Inc., in New York.
Money market funds are "one of the few areas where you can't use the competitiveness of the investment industry to your advantage," says Larry Busch, a CFA with MR Weiser & Co. in New York. "You can't go to the Morningstar database and find the best money market fund."
Busch says he'd like to see the custodians "break out of the traditional mold" and put money market funds on a supermarket platform like mutual funds. "There needs to be a lot more competitiveness in the marketplace" in the money market fund area. "But because these firms derive so much revenue from the money market products, it will be difficult for them to break away from using their own product exclusively." Custodians charge an expense ratio, or management fee, he says, so if they open up their offering to include other money funds they lose out on the management fee, and in some cases it's as high as 1%.
Busch says he uses Schwab Institutional's platform of money funds, and that Schwab's array of fund categories matches those of other brokerage firms. But "it's more the issue of choice," he says. "Having the choice of using other money market funds would certainly be of interest. I know, for example, that Vanguard, Reserve Funds and Weiss, Peck & Greer all have very high-quality money market products, and it would be nice if I had the option of having that choice."
Cash Is Still Valuable, If Not King
Bruce Bent II, president of New York-based Reserve Funds, the inventor of the money market fund, says he noticed advisors were feeling constrained by their money fund choices when they started flocking to Reserve Funds' FDIC-insured account. "The lack of choice [in money market funds] became more apparent when we began offering more choice, with the FDIC-insured money market account being the most potent example of that. When we came out with the first FDIC-insured money market account, it was the advisors that really grabbed on to it with both hands right away." He says advisors sought the FDIC-insured account to differentiate themselves in the market via a cash product and to justify their fees.
"[Advisors] are looking for best-of-breed products in a lot of different areas as far as investments are concerned, and this [FDIC-insured deposit account] came up on the radar in terms of cash," Bent says. He says the FDIC-insured account also allows advisors to lock up cash relationships with clients. "Advisors are acutely aware that with the repeal of Glass-Steagall, and everybody trying to eat everyone else's lunch, that cash management is an offensive and defensive tool. Everybody's clients carry a credit card and cash in their pockets, so cash is very much a part of a client's daily life. And whoever is providing [a cash account] has a constant relationship."
When advisors have a lack of choice in money funds, "not only is it a restriction, but it can be a risk if your single choice confines you to money market funds that invest in commercial paper," Bent says. If this is the case, the advisor "could be dealing in unproductive, if not embarrassing, phone calls to clients if that money market fund holds commercial paper that defaults, and we've seen defaults recently." Reserve Funds doesn't invest in commercial paper, he says, deeming it inappropriate. At the very least, he says, advisors should be conscious of whether or not a money fund they hold invests in commercial paper.
Eric Lansky, Reserve Funds' director of marketing, says FDIC-insured accounts are also a way for advisors to plan for T+1. Once next-day settlement is enforced, it will become critical for clients to have cash on hand in order to place trades.
Another issue that crops up with wirehouse money fund platforms is that they're usually built off a retail platform, not an advisor platform. The problem here is that if an advisor has a high-net-worth client with tens of millions of dollars sitting in cash, the advisor doesn't have the ability to offer an institutional fund.
Tom Bradley, President of TD Waterhouse's Institutional Services, says Waterhouse receives few complaints from advisors about its money market fund offering. But Waterhouse is considering offering an institutional money market fund within the next six months.
Bent says Reserve Funds has introduced more institutional money market funds over the past year, and the fund company offers the lowest expense ratio in an institutional money market fund--eight basis points. Reserve Funds also continues to build single-state tax-exempt funds, Bent says, because there's increased demand for these funds as a differentiator. Further-more, Bent thinks that offering these types of funds will entice higher-net-worth clients who are more sophisticated and more tax-sensitive. "Say you've got that million-dollar client who's a resident of Michigan. It may be very important that you offer a Michigan tax-exempt money market fund."
Since cash management is Reserve Funds' "claim to fame," Bent says, the fund company is constantly trying to stay ahead of the curve in product enhancements. For instance, Reserve Funds' FDIC-insured money market account is the only one that offers unlimited transactions, he says. And pretty soon the fund company plans to boost the FDIC insurance to $300,000 from $100,000.
Lewis Altfest, who uses both Schwab and Waterhouse platforms, says getting hold of state-specific municipal funds is a problem for him. "I would like a New York muni fund for New York residents, a New Jersey muni fund for New Jersey residents, a Connecticut muni fund and so on," he says.
Harold Evensky, with Evensky, Brown & Katz in Coral Gables, Florida, says if a client wants a state-specific tax-exempt fund and an advisor finds it's not available on his platform, he will likely lose that client "because there's just too much competition out there. Before, there was just nowhere else to go." He says advisors must take a more aggressive stance in offering more products and services to protect themselves from the brokerages that are marketing themselves as financial planners. With FDIC-insured money market accounts, "you don't have to go to a bank to get that," Evensky says. Clients "can now get [this product] at a huge company that's presenting itself as a financial planning firm."
Evensky says his planning firm's move to a private-client office structure is just one way to ward off competitors. "We are aggressively moving our model to be much more comprehensive in services because there's a lot of competition," he says. "We need to offer comprehensive answers to all [a client's] questions. Any advisor who thinks they can maintain business doing it the old way is going to be in trouble."