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How to Make It in a Low-Fee World: Cerulli

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Low interest rates and muted expected returns from equity markets are exposing the high cost of owning an investment portfolio, which can total more than 2% per year in fees to advisors and product manufacturers, according to a new report from Cerulli Associates.

“During the past several years, the magnitude of fees has become a challenge that directly affects the way in which financial advisors construct client portfolios,” Cerulli associate director Tom O’Shea said in a statement.

Long unaware of the level of fees and the type of fees they pay, consumers are increasingly waking up to these fees, and new regulations have spotlighted high-priced investment vehicles.

“In this environment, advisors must be sensitive to net-of-fee performance, and they must consider fees as one of the most important factors in constructing portfolios,” O’Shea said.

The February Cerulli Edge report says advisors are exploring ways to use low-cost investment vehicles when constructing client portfolios.

Asset managers surveyed by Cerulli said they expected I-share mutual funds, which are sold to institutional investors and often have no load and a low fee structure, to increase by 64%; R-share funds, created for retirement plans, to rise by 54% in 2017; and A-share funds, which commonly have a loaded fee structure, to decline by 66%.

The report says that the need to reduce portfolio costs is one factor driving adoption of exchange-traded funds and index funds. Low fees relative to other products and marketing support from ETF providers are the most important reasons advisors adopt these vehicles.

Sixty-six percent of sponsors rated fees as “very influential” in an advisor’s decision to use ETFs instead of mutual funds.

The next wave of innovation within the target-date industry may bring it closer to a managed account service, one of the three possible qualified default investment alternatives named by the Department of Labor in 2007, according to Cerulli.

Some providers are looking for the best way to best incorporate another layer of customization to target-date investing, specific to an individual participant, without jeopardizing the qualities that have made target-date funds successful asset gatherers: a scalable, reasonably priced solution that offers dynamic asset allocation without requiring participant input.

The report says a hybrid target-date to managed account solution allows for greater customization at the participant level, but without subtracting from the primary drivers of success for target-date funds.

Institutional investors have been using goals-based planning to match future liabilities with cash flows for a long time, according to Cerulli. Now advisors are adopting this approach with retail clients, especially with high-net-worth clients who have complex and often competing future goals, as a way to retain and grow existing assets.

Embracing goals-based investing adds meaningful value for clients.

The report says goals-based investing can increase trust and confidence, improve the approach to risk and customize service offerings. It engages clients from the outset by having them actively involved in the decision-making process without requiring an in-depth level of investment knowledge.

Cerulli suggests that advisors explore alternative pricing models. It says use of low-cost investment vehicles can generate only so much savings, particularly because managed account sponsors have placed downward pressure on managers for years.

“At some point, advisors need to scrutinize their own fees.”

— Check out What’s Next for DOL Fiduciary Rule on ThinkAdvisor.


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