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Industry Spotlight > Advisors

Why RIA Advisors Are Better Fund Pickers Than BD Reps: Study

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What You Need to Know

  • Dual registrants act more like BD advisors when selecting funds, mainly basing decisions on past performance, a new study shows.
  • RIA advisors are far more likely to consider expense ratios and to choose passive strategies.
  • Lower costs are linked with better fund performance; recent fund returns are not.

Advisors working with just broker-dealers and those affiliated with firms that are both registered investment advisors and BDs — so-called dual registrants — are more likely to be biased toward active funds than those working purely with independent RIAs.

This is one reason the funds they select underperform those picked by RIAs, who focus largely on expense ratios, according to a new study published by the Financial Planning Association, “Does Advisor Channel Influence Passive Fund Choice?”

Why do these advisors choose funds differently? While several factors are involved, the research highlights the fact that advisors working with BDs and dual registrants may be compensated by commissions and asset management fees, depending on their relationships with clients.

The recent study on the fund underperformance in certain advisor channels — conducted by Michael Finke, professor at The American College of Financial Services; Aron Szapiro, head of Morningstar’s Center for Retirement and Policy Studies; and David Blanchett, head of retirement research for PGIM DC Solutions — has these key findings:

  • Historical differences in how advisors with broker-dealers, RIAs and dual registrants are compensated can affect how they select funds.
  • Advertising by active-family funds promotes recent performance returns, which may appeal to investors and “reward commission-compensated advisors” but don’t predict future performance.
  • RIA advisors “favor more salient” characteristics such as expense ratios, whereas BDs and dual registrants favor recent returns and active investing strategies.
  • RIA advisors are more likely to follow passive investing strategies.
  • The findings also show the conflicts that favor promotion of active investing strategies among advisors who are regulated as fiduciaries.

The email survey of 811 responses who were registered with Morningstar.com was done in September 2020. Of that group, 459 were evaluated — a sample consisting of 37.5% RIAs, 33.8% BDs and 29% dual registrants.

Blanchett said in an email to ThinkAdvisor that the focus of the survey was on what attributes advisors consider when selecting funds.

“All three channels considered expense ratio when selecting investments, but RIAs considered them at a significantly higher rate than BDs,” he explained. “The expense ratio doesn’t necessarily mean passive versus active; it just means you’re focused on the fees associated with different products/strategies when using them for clients.

“Passive strategies are generally lower cost (so these two are related), and an additional test did demonstrate that RIAs are much more likely to favor passive investments, too, though. So, advisors with BDs are more focused on performance, while RIAs are more focused on expenses (and as such are more likely to go passive),” he said.

The RIA representatives in the sample were slightly younger than other advisors and had fewer clients. A majority of advisors with BDs and dual registrants had more than 50 clients and 10 years in the business. 

More advisors with RIAs, 24.2%, had more than $200 million in average assets under management vs. 17.3% for those with dual registrants and 14.2% of advisors with BDs. Most respondents, roughly 80%, were male.

Passive Tilt — or Not

Thirty-seven percent more RIAs evaluated expense ratios when searching for mutual funds than advisors in the other two groups, “and representatives from broker-dealers are least likely to consider fund expense ratio,” the report states. 

Also, one-third of RIAs build client portfolios mainly with passive investments, “which is more than twice the percentage of broker-dealers (16.1%) and dual-registrant advisors (15.8%).”

The survey also showed the odds that advisors with RIAs consider the expense ratio when recommending a specific mutual fund are 121% higher than for advisors with BDs and dual registrants. Further, the odds that advisors with RIAs follow a primarily passive investment strategy are 83% higher than for those with BDs.

The study concludes that “dual registrants operate within a brokerage ecosystem that may influence how the advisors are trained to select fund investments and develop an investment strategy.

“If they are trained to favor a method of evaluation that promotes selection of actively managed mutual funds, then prior studies of fund performance predict that the investment portfolios of their clients will underperform by roughly the difference between the expense ratios on active and passive funds,” it states. “This performance deficit is magnified when asset fees are added to the negative alpha generated historically by active funds.”

Bottom line: Independent RIAs “are far more likely to value information on the most important characteristic predicting future returns (expense ratio), to select passive funds, and to implement a passive investing strategy than broker-dealer representatives.”

In addition, the researchers found “no evidence” that fund characteristics favored by dual-registrant reps differ from BD reps when researching which funds to recommend to clients. 

As Blanchett told ThinkAdvisor, “Dual registrants are kind of in between [advisors affiliated with or working for] BDs and RIAs; the analysis would suggest that their selection behaviors are more similar to [those tied to] BDs than RIAs though.”