BlackRock, Schwab ETF War Alters Retirement Advising

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By Sean Forbes

Oct. 18 — Wall Street financial advisory firms such as BlackRock Inc. and Charles Schwab Corp. are adapting to the post-DOL fiduciary rule by chasing each other to lowest-fee exchange-traded funds—and the companies’ performance shows that these moves are healthy for the bottom line.

The intensely competitive fight over low-fee ETFs is a huge advantage for retirement investors and advisers who don’t work on commission, retirement advisers and researchers told Bloomberg BNA.

The Department of Labor’s rule requires financial advisers to put their clients’ interests ahead of their own when providing retirement investment recommendations. The final rule was released in April and begins to take effect in April 2017. Firms must be in full compliance by January 2018.

Schwab cut prices on five of its ETFs on Oct. 7, just two days after BlackRock intensified the price war in the industry by reducing expenses on 15 of its funds.

Asset managers, including Vanguard Group and Fidelity Investments, are engaged in a race to the bottom to attract money to the fast-growing U.S. ETF market, which drew $162 billion in investor cash this year, according to data compiled by Bloomberg. Investors continue to pull money from actively-managed mutual funds, which have struggled to beat their index benchmarks. Most ETFs mimic indexes.

And ETFs have surpassed every other investment vehicle among those that advisers use or recommend to their clients. From 2006 to 2016, advisers more than doubled their ETF use from 40 percent to 83 percent, according to a survey conducted by the Journal of Financial Planning and the FPA Research and Practice Institute.

Additional studies show the clear surge in ETF use. The combined assets of U.S. ETFs were $2.374 trillion in August, up 19 percent over the past 12 months, the Investment Company Institute said in a Sept. 29 statement.

In a 2015 study, Schwab found that the availability of ETFs in 401(k) plans was the third-ranked game-changer for the ETF industry. The top two game-changers were lower operating expenses and commission-free ETF offerings.

BlackRock and Schwab

BlackRock’s third-quarter performance, for example, shows how well some companies have gained under the new regulatory environment. Profits rose 3.8 percent in the third quarter as the firm cut costs on while assets under management increased, the company said in a statement released Oct. 18. Part of the boost in AUM came from $51 billion on net flows into ETFs in the third quarter.

“Regulatory change continues to have a material impact on our industry,” Chief Executive Officer Laurence D. Fink said in the statement. “In retail, the DOL fiduciary rule will increasingly influence the choices that financial intermediaries make for their clients.”

At Schwab, commission-free ETFs have been a mainstay since before the DOL embarked on its expansion of its fiduciary rule, Alison Wertheim, a company spokeswoman in San Francisco, told Bloomberg BNA.

As of the end of the second quarter, Schwab had 10 million active brokerage accounts, 1.6 million corporate retirement plan participants, 1.1 million banking accounts, and $2.62 trillion in client assets, Wertheim said. Schwab’s third quarter results are due this week.

Winners and Whiners

The race to lowest-cost ETF fees may be an intended effect of the conflict of interest rule, much to the benefit of investors.

“I would say that at the highest level, consumers are winning and wirehouses are whining,” Matt Hall, co-founder and president of Hill Investment Group, in St. Louis, told Bloomberg BNA.

The rule’s transparency requirement is one of the major reasons that investors will benefit from ETFs, Hall said. Active money managers that claim to have a strategic advantage will have to prove their mettle, he said.

“No one’s going to pay for the gunslinger or the guru” who can’t demonstrate repeatable positive returns, Hall said.

Advice and ETFs as Commodities

Ultimately, low-fee ETFs are great for investors, but not the end-game for advisers, said Jim DeCarlo, chief executive officer of StratWealth LLC, in Columbia, Md.

“Is it a race to the bottom, to zero? No, it’s a function of advice becoming more transparent and the cost to invest coming down,” DeCarlo said. “So the planning industry is going to blossom from this moment forward. Planning will win the game” and become a “commodity,” he said.

“Commodity” is a word that Michael Kitces, partner and director of wealth management at Pinnacle Advisory Group, in Columbia, Md., also used, but to describe the ETFs.

The ETF price fight among the providers isn’t “based on a CONCERN about the DOL fiduciary rule, per se,” Kitces told Bloomberg BNA, adding the all-caps emphasis. “It’s based on the OPPORTUNITY of the DOL fiduciary rule. ETFs—particularly those that track known indexes—are a commodity, for which the prime determinant is cost,” as with any other commodity, he said.

Pairing fiduciary-level requirements with low-cost ETFs will result in an all-out war among the companies in each ETF category, Kitces said.

“A prudent expert rule plus a commoditized product is a ‘winner takes all’ market,” Kitces said. “These companies are fighting with each other to be the winner.”

What’s Next?

Ultimately, the impact of the fiduciary rule on ETF fees was foreseeable, John Scott, director for retirement savings at Pew Charitable Trusts, in Washington, told Bloomberg BNA.

“None of this is surprising at all in part because this rule was more or less out there for several years,” Scott said in an e-mail.

However, the industry has adapted in other unpredicted ways besides cutting ETF fees, such as with the rise of robo-advisers, Scott said.

And there’s room for more surprises. “What will be interesting to watch will be the unanticipated changes because this rule will take years to play out,” Scott said.

To contact the reporter on this story: Sean Forbes in Washington at sforbes@bna.com

To contact the editor responsible for this story: Jo-el J. Meyer at jmeyer@bna.com

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