ETF Use Distinguishes Brokers From Financial Advisors

Cogent Syndicated report shows RIAs pulling away from brokers when it comes to using low-cost ETFs in client portfolios. 

Financial advisors continue to embrace ETFs, and they’re proud of it. 

“Follow the money; the answer is fees,” said Thomas Balcom, founder of 1650 Wealth Management. 

“Nearly all RIAs are fee-only advisors; hence their ability to use low-cost ETFs within their portfolios and still be compensated by their clients,” he added. “If you’re a broker, you may only be able to earn a modest commission, if anything, on purchasing an ETF for your clients; hence the aversion to these investment vehicles.” 

According to the latest research from Cogent Syndicated, an average of 30% of RIA assets is allocated to exchange-traded funds in client portfolios, which is up from 29% a year ago. Brokerage firms, meanwhile, are seeing reps allocate an average of just 17% to ETFs, which is up from 15%. 

“Brokers are tied to the legacy model of using their in-house fund families and the brokers tracking the results, which is harder with ETFs,” said Noah Damsky, principal at Marina Wealth Advisors. 

“This is why DFA hung on to mutual funds and resisted ETFs for as long as they could,” he explained. “RIAs are more associated with independent models, which is more similar to ETFs. This trend should continue as RIAs continue to take share and since ETFs are more tax efficient and lack the high transaction costs and gates to transact of mutual funds.” 

As a former broker, Laura Lynch, founder of The Tiny House Adviser, said the difference often boils down to where the incentive rests. 

Financial Advisors Need to Evolve Their Client Relationships 

“Broker-dealers that serve retail clients are still incentivized to sell investments through commissions, and mutual funds are one investment that has baked in commissions,” she said. “The move to ETFs will require advisors to evolve the nature of their client relationships from sales to advisory or fee for service.” 

Derek Williams, wealth advisor at Veratis Advisors, agreed that ETFs are good fits for the fee-only models used by a lot of RIAs. 

“With ETFs, there is no load or other large commission that might be paid for selling a mutual fund under a commission structure,” he said. “Additionally, more clients are interested in index investing, and it’s becoming more of a mainstream topic. As more and more clients expect advisors to offer passive options, ETFs become the vehicle to implement that change.” 

Then there are the lower fees for ETFs, which mutual funds have struggled to compete with. 

“Many RIAs are leaning heavily into using ETFs because they want to reduce the overall client fee without reducing their advisory fees,” Williams said. “When you're feeling pressure to reduce fees, it's much easier to reduce your portfolio-level costs by using ETFs than it is to reduce your advisory fees.” 

Linda York, senior vice president at Cogent Syndicated, underscored the fact that fees have been a driving force connecting RIAs with ETFs. 

“Brokers are catching up, but RIAs still tend to be more fee conscious, which means less commissions,” she said. 

According to the Cogent research, 89% of RIAs are earning at least 75% of their total compensation from asset-based fees. 

That compares to brokerage firms, where 52% of reps are earning at least 75% of total compensation from asset-based fees. 

The bank channel continues to represent the last holdouts on asset-based fee models, with just 28% of bank reps earning at least 75% of total compensation from asset-based fees.