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September 28, 2015 at 08:00 PM
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, ETF.com’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.
