- Market Commentary
- By Jack Ablin
- October 29, 2019
Trading Commissions Imploding as Investors Go Independent
It’s a race to the bottom for some players in the $74 trillion asset management business as investors wrest control of their assets from bulge-bracket private banks, active managers and full-service brokerage firms. This tectonic shift is accelerating, prompting a realignment in the industry. The latest quake was discount brokerage Schwab eliminating commissions for stocks and exchange-traded funds; TD Ameritrade and Fidelity quickly followed suit.
Schwab’s competitive positioning was clear: the discount broker derived less than 10 percent of its revenue from trading commissions, one of the lowest in the industry. It earns a greater share of its revenue from net interest and asset management fees. In contrast, one-quarter of TD Ameritade’s revenue was derived from trading commissions; no wonder its stock plunged 25 per cent in response to the news. It’s estimated that the company will need to raise an additional $60 billion of assets to offset the $100 million per quarter of forgone trading revenue.
The move to eliminate trading commissions follows a decade-long trend toward lower fees for investors. The exodus from higher-fee, actively managed mutual funds toward low-cost, passive strategies is the catalyst, for good reason. Fewer than 18 per cent of actively managed US large cap funds have outperformed the S&P 500 over the last 5 years through 2018. Even Warren Buffet’s Berkshire Hathaway has trailed the S&P by more than 10 percentage points over the last 5 years. The Oracle of Omaha also fell behind the market on a 10-year basis. While active managers are losing out to their lower-fee indexed competitors, the shift toward passive funds resulted in $5.5 billion in savings to investors last year, according to Morningstar. Investors are paying roughly 25 percent less to own funds today than they did 5 years ago. In fact, index fund assets are poised to overtake those of actively managed funds by 2021, according to Moody’s Investor Service.
The regulatory environment has also spurred the industry to move away from commission-based investing, putting bulge-bracket brokerage firms at a disadvantage. Regulations have forced the unbundling of research services and data from large banks and brokerages, allowing for the democratization of information. No longer do the largest institutional investors have exclusive access to data and expertise.
Democratization of the industry has given an edge to independent, fee-based registered investment advisors (RIAs). Clients of independent advisors have the flexibility to hold their assets at their choice of custodians, including Schwab and others where trading commissions are free. Clients of private banks are required to hold their assets at the bank, where transactions are not necessarily commission-free and access to low-cost or zero-cost funds is unlikely.
As a result, growth among independent advisors is booming. Assets under management in the RIA channel grew $1.2 trillion last year, according to a recent Barron’s report. RIAs oversaw a total of $83.7 trillion in assets as of 2018. Fee-based independent advisors who act as fiduciaries, like Cresset, are best positioned to benefit from these industry trends. Their ability to act objectively, select low-cost, tax-loss harvesting strategies and leverage zero-commission platforms positions them and their clients for success. Expect to see RIAs continue to grow, drawing assets from their larger, higher-cost competitors; they, too, are likely to eventually become household names.