As fees for investing portfolios fall, big Wall Street firms are emphasizing advice. But new services threaten their dominance of that business, especially when it comes to younger investors.
Jack Bogle, the founder of Vanguard Group and the pioneer of low-cost index investing, has won.
Data shows investors have steadily paid lower mutual fund fees every year since 2003. Some 35% of all money in mutual funds is managed passively by computer models instead of humans. The average upfront sales fee paid to brokers by mutual-fund investors has fallen 74% since 1990, according to the Investment Company Institute trade group.
At the recent Reuters Global Wealth Summit, “transparency” and “fees” were among the most popular words spoken by top wealth and asset management executives.
“All of the sudden, everybody understands that high cost is your enemy and low cost is your friend,” said Bogle, 85.
Yet he is not ready to rest on his laurels. And that is bad news for the rest of the industry.
The win for budget-minded investors presents a dilemma for investment management firms ranging from Charles Schwab and Morgan Stanley to Blackrock. How do they remain profitable when their bread and butter, transactions, are being commoditized?
Furthermore, coming down the pike behind the low-cost indexers is the next generation of robo-advisers: Algorithm-driven, web-based advisory startups such as Wealthfront, Hedgeable, and SigFig, which promise to manage portfolios for just a few cents on the dollar.
Some speakers at the summit hypothesised that average advisory fees ultimately could collapse to 0.5% of assets under management under those competitive pressures.
Executives from mainstream firms are taking a few different tacks. Most, such as Schwab and Morgan Stanley, are de-emphasizing investment products, and focusing instead on offering advice to consumers, a trend that has reached critical mass.
In 2013, Morgan Stanley’s wealth management unit made $7.6 billion, or 54% of its revenues, from asset management fees, instead of commissions, which made up only 15.5% of net revenues. The remainder was in investment banking, investment income and some other categories.
The firm currently has 37% of its assets in so-called fee-based advisory accounts and is aiming at 40%, wealth and investment management head Greg Fleming said at the summit.
At Schwab, originally conceived as the firm for do-it-yourself investors looking for low-cost trading, all the talk is about connecting on a human basis.
There is a “relentless move to, ‘I would like a person to talk to about my goals and markets and my portfolio,’” said John Clendening, executive vice president and co-head of the firm’s retail business.
“We launched our first advisory solution in 2002. Fast forward to today and we have $163 billion in client assets in advisory solutions,” the main Schwab fee-based approach.
Bank of America’s Merrill Lynch is recruiting new advisers who will take up its emphasis on a “goals-based” approach, said John Thiel, the head of US Wealth Management and Private Banking at Merrill.
“We knew we could do a better job where we talk about life priorities versus just numbers,” he added.
Even Blackrock, with almost $1 trillion in assets in its low cost, indexed iShares exchange-traded funds, is intent on marketing its higher-fee products, such as hedge-fund-like ETFs, to advisers.
Frank Porcelli, managing director and head of Blackrock’s U.S. retail business, said his firm sends experts out to talk to advisers about how alternative funds can fit into advisory plans.
“Advisers are moving from the traditional business model to platforms where they charge one holistic wrap fee and then they can put anything in that portfolio they want. They are positioning themselves as portfolio managers,” he said.
THE 0.5% SOLUTION
But beyond all the lip service given to human advice in the post-2008-crisis marketplace is the fact that advice might be the next big area of commoditization.
Virtually all of the large and small brokerage firms that sent speakers to the summit talked about wanting to win assets from the under-40-year-old demographic. But they will be marketing themselves to generation Xers and millennials against (currently minuscule) data-driven upstarts such as SigFig, which aggregate portfolios of any size for free and offer fee-cutting investment advice for $10 a month.
Mike Kane, chief executive officer of Hedgeable, another automated advisory firm, told summit attendees he expects the industry average fee to coalesce to around 0.5%, which would be 50% lower than the current 1% industry standard. That was the same figure Bogle said he saw in the future for financial advice.
Although global wealth and the number of wealthy individuals continue to grow and the competition is fierce, even the upstarts do not expect to replace the old line multi-trillion dollar brokerage/asset management firms any time soon.
There will be room for multiple models; for clients who want algorithms and clients who want to talk to humans and clients who want to buy specialized products that will cost more than the Bogle bottom line, said Kane.
“My dad is a financial planner,” he added. “I don’t want to put my dad out of business.”