The continuing shift to the fee-based model in the financial advisory business and away from commission-based compensation can be thought of as a persistent bid under the $1.3 trillion ETF market.
Along with the rise of ETF model portfolios and active ETFs, this trend is one of the most important factors that will drive the industry’s growth in coming years.
Fee-based advisors typically charge clients a percentage of assets under management.
“The investment business is undergoing a tectonic shift right now, some aspects of which are unseen by the public. One of these clandestine transformations, cloistered from the public view for the most part, is the move from a transactional or commission-based model to an assets-under-management or fee-based model for financial advisor compensation,” Josh Brown explained in a WSJ blog post last year.
“For the most part, this transition has been a benefit to the general investing public as it has removed much of the inherent conflict from the days of transactional stockbrokers,” he added. “High-cost products like A-share mutual funds with 5% sales loads are also waning in popularity as more clients become advisory versus brokerage and more practitioners utilize ETFs on their behalf – vehicles without sales loads of any kind that also tend to carry lower internal expense ratios.”
The average actively managed fund has an expense ratio of about 1.3% while the average expense ratio of an ETF is 0.55%, according to Tom Madell, publisher of Mutual Fund Research.
Some ETFs are incredibly cheap. For example, Charles Schwab recently cut expense ratios on some of its ETFs down to just 0.04%. Also, Schwab clients can trade its ETFs without paying commissions, and the firm isn’t the only one offering rock-bottom ETF fees and free trades. [Schwab Cuts Fees on 15 ETFs]
Merrill Lynch’s recent move to raise its minimum charge for stock trades could provide more fuel to the shift to fee-based advising, the WSJ reports.
“For years, major brokerages have tried to make fee-based relationships a bigger part of their business, and to reduce their dependence on per-transaction charges for revenue,” according to the article.
“The serious money is in fee-based,” said a Merrill financial advisor and branch manager. [Fee-Based Advisors and Managed ETF Portfolios]
“The growth of the fee-based advisor over the last five years has been remarkable, and it was probably keyed off of the events of 2007 and 2008. It’s not a temporary trend, it’s a permanent change in the way advisors view themselves,” Paul Hatch, vice chairman of Morgan Stanley, said in an AdvisorOne report.