If ETF Fees Are Falling, Why Do Advisors Cost So Much?

In the last few weeks, there have been two new developments in the ETF price wars that are important to Wealthfront clients and investors in general – moves by Vanguard and BlackRock that will significantly lower ETF fees. At the same time, we’re starting to see the media raise the question that’s been on my mind lately: Why do traditional advisors charge so much when the underlying investment products (the ETFs) are getting cheaper and cheaper?

Jeff Rosenberger, PhD, Wealthfront's Director of Research

Two weeks ago, Vanguard announced it will change the indexes it uses for 22 of its index funds and ETFs. For instance, it will now use FTSE for international indexes in place of its previous index provider, MSCI.

Most people don’t realize the publishers of indexes charge fund managers like Vanguard a fee to use their indexes. License fees can range from 0.02% to 0.30% of an index fund’s assets. For Vanguard, the license fee probably represents its largest cost. By moving to new but still appropriate indexes, Vanguard is able to significantly lower its costs. As essentially a not-for-profit company (like a mutual savings bank, Vanguard is owned by the investors in its funds, not by shareholders), it can then pass along all of its savings to investors, thereby maintaining its role as cost leader.

On a side note, it was notable to us that Vanguard is able to make this switch without triggering capital gains taxes for its clients, because it’s been using tax-loss harvesting (TLH) within their ETFs. The company will reallocate $10B in its funds (see this article from Bloomberg and this piece by investment columnist Rick Ferri for more details about the changes and how they’ve affected the market). Vanguard expects basically no capital gains distributions from the transition, because it is managing the process over six months and using TLH. Wealthfront is now offering automated, continuous TLH – historically available only to institutions and clients with at least $10-$20 million in their portfolios – to our clients with accounts of $100,000 or more.

BlackRock’s News

On the heels of Vanguard’s announcement, BlackRock, whose iShares unit is the largest ETF provider, said it is slashing fees on six of its iShares exchange-traded funds and introducing four new ETFs. BlackRock is responding to intense competition in the ETF market, which is basically, for fund companies, the best growth opportunity out there. BlackRock has 41% of the market, though its share has declined from 48% in 2009. Vanguard, the third-largest ETF provider behind State Street Global Advisors, has seen its market share increase to 18% from 12% during the same period. State Street’s market share has remained flat at about 25%, according to The Wall Street Journal.

Both company’s moves are good news for investors, as earlier developments in the ETF price wars have been, too.

Competition is driving down the costs of ETFs, so that many fees are below 0.15%, and some are below 0.10%. On the average portfolio chosen by Wealthfront for its clients, the ETF fees are 0.14%.

Wealthfront chooses the ETFs for its client portfolios based on fees, tracking error and liquidity, as you can see from our plan page. We’re carefully examining the iShares cuts to see if it makes sense to replace any of our currently recommended ETFs.

Whack-A-Mole

The financial services industry is like a whack-a-mole game: when costs fall in one place, they rise in another. While costs continue to fall on the ETFs themselves, some advisors are marketing new ways of combining ETFs, adding new fees for complexities that are of questionable value.

Last weekend, Jason Zweig of The Wall Street Journal wrote:

Exchange-traded funds have quickly become one of the cheapest and simplest investing tools in the world. They also are the raw material for an increasingly popular but potentially expensive and confusing way to invest.

He goes on to discuss the way some traditional advisors are setting up ETF portfolios for their clients and charging 1% to 3% of assets under management for them.

Wealthfront’s clients don’t need to worry about this: We’re mentioned in the article as one of a handful of low-cost online alternatives. But the way traditional advisors are layering new fees into ETF portfolios is a reminder that investors should be vigilant, always, about fees. The headlines are reassuring: ETF fees are falling. The bottom line on your account statement may not make you so happy.

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3 Responses to “If ETF Fees Are Falling, Why Do Advisors Cost So Much?”

  1. trdninj October 21, 2012 at 6:27 am #

    I have direct view of low cost ETF investing being converted into high-fee business in private wealth management. The firm with which I am familiar has several ways of doing so. 1) they have created “tactical” ETF portfolios (sometimes even double repackaged to call it “dynamic tactical”) charging a fee under the guise that they have some special technical trading insight (based on newsletter sentiment etc.) that signals them to move funds around various wild sectors (Malaysia, TVIX, gold juniors) based on momentum and economic recognition. Of course they hang their CMT and CFA certificates on the wall while still drastically underperforming passive, low cost investing. But they make very nice coin. 2) “portfolio managers” in a special advisory program are allowed to charge high advisory fees (1.25%) for their “specially designed” portfolios of ETFS (which of course layer additional fees onto the client). These “portfolio managers” (in another era called stock brokers) have absolutely very low financial technical expertise (but they do read Barron’s and have CNBC on in their offices, they tell me, to stay abreast of the relevant trends) in investing but do have expertise in formulating marketing plans and sales presentations – they make over 40% of “production”. It is all very beyond nauseating.

  2. Jeff Brown October 22, 2012 at 3:07 pm #

    What I find most interesting about the rise of big bot firms is their tendency to categorize all advisors are “costing too much” or, more directly, not acting in the best interest of their clients. I am not an advisor although I work with one. And I will admit that many – dare I say most – embedded financial institutions have an very vested interest in not changing the wealth game.
    Like all industries, it is buyer beware. There are both good and bad advisors out there. As there are both good and bad big-bot investing companies. Some bots will suggest that real wealth planning involves only low-cost index investing. And while some advisors (like mine) agree with this approach, real wealth management includes Planning, Risk Management and Estate Planning. Low-cost fees are great for the consumer and I hope advisors come to embrace it. So while I like and recommend bot-firms like WealthFront, I don’t pretend that they offer more that 1 or the 4 pieces of Wealth Management. It is a great place to start investing for people with limited assets. But the comparing bots to an advisor is like saying a backyard rocket is the same as a passenger jet. They both fly, but are in totally different spaces.

    • Elizabeth MacBride October 29, 2012 at 9:15 am #

      Thanks for your response. Our clients — young people — prefer to have the option of getting their advice online, and from a software-based approach that isn’t biased and is low cost. Many of our clients tell us they’d pay not to have someone contact them.

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