Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Portfolio > ETFs

How the Wirehouses Embraced ETFs

Your article was successfully shared with the contacts you provided.

As the exchange-traded fund marketplace continues its explosive growth, wirehouses and other large broker-dealers have emerged as a formidable rival channel to the registered investment advisors that historically have been the top distributors of ETFs.

A key factor behind the surge of big broker-dealers in the ETF space is that their advisors are increasingly committed to the fee-based structure that RIAs adopted years ago as their compensation model.

“The RIA channel continues to have the most growth assets, but wirehouses have moved into second place in terms of the growth of ETF assets over the past year,” said Frank Polefrone, senior vice president of Broadridge Financial Solutions Inc.’s Access Data product suite.

Morgan Stanley Wealth Management’s experience reflects what is now happening in the broader wirehouse and large broker-dealer world. The wirehouse is embracing ETFs, now at $118 billion of assets in portfolios, with education offerings for advisors and a team of four research analysts who cover nearly 90% of ETF market capitalization. In addition, Morgan Stanley is combing through its in-house databases to track advisors’ ETF use and make investment recommendations.

“We’re seeing more usage in our fee-based accounts. ETFs work well in the fee-based model. It’s a primary growth engine of Morgan Stanley Wealth Management,” said Michael Jabara, Morgan Stanley’s research head.

Data Tell Story

Broadridge’s data analytics unit reports on 95% of all ETF assets, including those of the three largest issuers, and the technology firm is seeing a growing trend in ETF use at the wirehouses and broker-dealers. Broadridge has access to the issuers’ data because it provides investor communications for broker-dealers and other financial services firms.

Meanwhile,’s league tables in August show BlackRock Inc.’s iShares leading the three largest issuers, with approximately $775 billion in assets under management (AUM), followed by The Vanguard Group Inc., with roughly $458 billion, and State Street Global Advisors’ SPDRs, with about $397 billion.

As of June 30, total ETF use stood at $2.2 trillion, according to Broadridge. RIAs held $496 billion of those ETF assets, or 22.5%, while wirehouses held $397 billion, or 18.0%, and independent broker-dealers held $391 billion, or 17.8%.

In comparison, total ETF use at the end of second-quarter 2014 was $1.94 trillion, with $418 billion held by RIAs, at 21.5%, $327 billion held by wirehouses, at 16.9%, and $329 billion held by indie broker-dealers, at 17.0%.

Fee-Based Boom

Broadridge’s Polefrone said wirehouse advisors are more attracted to ETFs as they move away from commission-based transactions and gravitate toward investing in products with lower fees.

“As the market has moved toward advisors managing money in portfolios, it’s not just product or commission based. It’s a more holistic fee-based way of managing money,” Polefrone said.

RIAs are the largest channel because they’re already managing money holistically, he said, but added that as wirehouses move toward the fee-based model, they’re seeking products with a lower fee structure.

“ETFs play into that beautifully,” Polefrone said. “We’ve noticed over the past year that the growth primarily came from retail distribution channels, and by that we mean RIAs, independent broker-dealers, regional broker-dealers and wirehouses.”

Bloomberg and Vanguard data as of July 31 show that there are 1,764 products in the total exchange-traded product universe. Fully $1.75 trillion, or 84%, of the market’s $2.13 trillion in total ETP assets are flowing to 736 different products in the broad-based index ETF category, and the average expense ratio for those broad-based index ETFs comes to just 0.37%.

The fee-based advisory model is a big contributor to low-cost ETFs’ use at the wirehouses and large broker-dealers, said Ben Johnson, Morningstar’s director of global ETF research. Brokers who traditionally have been paid about 2% per year in transaction fees are more willing to move to an advisory fee-based structure if they can use lower-cost ETFs that won’t cut too heavily into that 2% payment level, he said.

“The economic rent is moving away from the individual funds for the client and taking the form of a fee on assets under management,” Johnson said. “Meanwhile, to keep the overall rent level, the portion of the rent on the underlying funds is coming down. An advisor charging a fee on AUM is more likely to use ETFs than someone buttering their bread with transaction business.”

Portfolio Building

Mike Lucci, a Vanguard Financial Advisor Services principal responsible for the firm’s broker-dealer group, said that as wirehouses and broker-dealers commit to the fee-based model, the door has increasingly opened to passive index funds.

“What we’re seeing is ETFs being primarily used as core building blocks of a portfolio. Some advisors use ETFs exclusively, but most are using active funds to bring additional alpha into the portfolio,” Lucci said.

He added that fee-based advisors typically charge clients in a range of 75 to 125 basis points on AUM for both portfolio management and financial planning.

David Mazza, head of ETF research at State Street Global Advisors, agreed that the wirehouses and large broker-dealers are embracing ETFs as part of their portfolio offerings.

“Wirehouses are encouraging their advisors to move to a fee-based advisory platform and away from a transactional broker model,” Mazza said. “A big driver is on the regulatory side, and you now have ETFs that can provide advisors with a multitude of markets and asset classes inexpensively and efficiently.”

Typically, advisors transitioning from commissions tend to charge a fee based on assets under management while also charging some transaction-based fees, Mazza pointed out.

“This is not happening overnight. It’s been happening for years. The reason we’re seeing the ETF data pickup is that for advisors undergoing the change to this business, ETFs have become a preferred vehicle,” he said.

Shrinking Gap

Interestingly, Mazza added, State Street’s ETF research shows a new trend emerging. The historically large gap between RIAs who dove into ETFs headfirst and brokers who relied on stocks, bonds and mutual funds has narrowed.

“Now, we’re beginning to see that the investment decisions of traditional wealth managers at RIAs and emerging financial advisors with a significant book of business at wirehouses are looking increasingly similar from a due diligence perspective,” Mazza said. “These folks’ move to a fee-based model has something to do with it.”

Mazza spoke of one wirehouse advisor in the Boston area with a considerable book of business who was unwilling at first to embrace change and slow to invest his clients’ assets in ETFs. The advisor grew successfully for years as a stock-picker, but then he saw the beginnings of a multi-generational wealth transfer, with new clients or the sons and daughters of clients who weren’t comfortable with his portfolios of 30 to 40 handpicked stocks, even if they were great stocks.

As a result, the Boston-based wirehouse advisor now positions country or industrial sector ETFs alongside the stocks in an existing portfolio.

“His differential is that he has ideas, whether his firm’s or his own,” Mazza said. “The client feels they’re still getting a hands-on experience and not just being put into a mutual fund. He has this stock portfolio, but he’s integrating a country or sector ETF. He’s bringing diversification to the client.”

Widening Landscape

Morgan Stanley is exploring ways for advisors to use ETFs as sales and net flows are booming, company executives say.

“The ETF landscape has really widened over the past few years,” Jabara said. “You can zero in on a particular area, like currency hedge products and smart beta ETFs.”

Managing director David Berdon added that Morgan Stanley is structuring model portfolios composed solely of ETFs, and that it is doing proprietary analysis that considers how to combine active and passive management.

“It’s a growth business at this firm, in line with what’s happening across the industry,” said David Rosen, the firm’s ETF product head. “There’s a higher level of comfort with the structure. How ETFs trade, liquidity, fees, tax and transparency are contributing to the growth.”

Mariana Bush, a senior closed-end fund and ETP research analyst with Wells Fargo Advisors, said her wirehouse firm also is seeing strong ETF flows among advisors. The product is simple and versatile and provides exposure to many asset classes and strategies, from equities to fixed income to commodities and currencies, to long-short and more, she said.

“You can go long gold but short the euro, and it’s as easy as trading a stock,” Bush said. “Before, you had to use futures, and not everybody had access to futures trades.”

Big Data

Like Morgan Stanley, Wells Fargo uses big-data technology to analyze how advisors are using ETFs. (Morgan Stanley executives also confirmed that they are compiling their data on ETF usage and selling it back to the providers.)

Morningstar’s Johnson said big data has been a boon for the ETF world; unlike mutual funds, which keep shareholder records, ETFs are traded on exchanges and thus keep no such records. As a result, investor behavior was tough to track until big data came along.

“The holy grail in the eyes of ETF providers is to know who their clients are,” said Johnson, noting that ETF providers such as BlackRock conduct user surveys. “The wires are going about it differently. They’re working toward compiling that data and selling it to the ETF providers.”

Amy Charles, managing director of closed-end fund and ETF research at Raymond James Financial, said RJ along with all the wirehouses and large broker-dealers have their own in-house databases to identify ETPs by symbol and track how they’re being used.

At Raymond James, Charles can find out whether advisors are using her idea list, and she can track by symbols to see what was bought one month ago versus six months ago. Or, she can get ahead of the news if an ETF gets into trouble and alert advisors.

In addition to their big-data push, wirehouses and large broker-dealers are focused on educating advisors and their clients about ETFs.

Since Charles joined Raymond James 20 years ago, when the universe of ETFs comprised only 19 funds, she has witnessed an explosion in the market. Today, Charles has two analysts dedicated to ETF research, with a main purpose of giving guidance and educating RJ’s financial advisors.

“We have our idea list and work with analysts to match a technically undervalued sector to the client when it’s a good time to enter the sector,” she said.

Edward Jones publishes ETF strategy reports along with a focus list with investment recommendations that advisors can pass on to clients, according to senior research analyst Katie Martin. The reports include information about portfolio exposure, underlying benchmarks and fund expenses.

Edward Jones typically recommends more broadly diversified stock and bond ETFs, Martin said. They tend to be lower cost, and they give exposure to multiple securities and aren’t driven by the performance of a single stock or bond.

“We think these broad-based ETFs can be used as the core building blocks of a portfolio, and they can also be used alongside individual stocks and bonds to provide low-cost, broad exposure to asset classes that can help further diversify a portfolio,” Martin said.

In the future, Broadridge’s Polefrone believes that while advisors are likely to follow the sort of broad-based, plain-vanilla strategy that Edward Jones uses, he also expects to see more growth in smart-beta ETFs, particularly at the wirehouses.

“We’ve already seen a big increase of ETF assets sold through the wirehouse channel over the last year. What seems to be driving that is smart-beta ETFs,” Polefrone said. “The wirehouses are the largest user of the smart-beta category,” which use alternative indexes in an effort to outperform the traditional cap-weighted indexes. Recent BlackRock iShares data uphold Polefrone’s prediction.

BlackRock’s monthly industry highlights for July 2015 showed that currency-hedged and smart-beta equity were the two fastest growing ETP segments, remaining steady with flows of $3.5 billion and $1.6 billion, respectively. Smart beta is still on track to reach the record flows from last year, according to BlackRock, with assets growing at an annualized rate of nearly 40% since the beginning of 2012, twice the rate for the broader ETP industry.


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.