Best Of 2016: Do Commission Free ETFs Sway Decisions?
The idea of commission-free ETF platforms is appealing, but offering a fund free of transaction costs may not matter that much to most advisors.
[Editor's Note: We are rerunning some of our best stories of 2016.]
There’s a growing number of ETFs being offered commission-free across various platforms. But when it comes to picking the right ETF for a client, are advisors swayed by the appeal of commission-free ETFs? In other words, is that a key driver in advisor choice of one ETF over another in a given segment?
The answer, put simply, is that it depends—and it depends primarily on the size of the advisory and the size of the account.
Michael Kitces, financial advisor and the author of the “Nerd's Eye View” blog, says that for most advisors who manage “fairly sizable ETF portfolios,” having a fund be offered commission-free “rarely” sways their ETF pick.
Expense Ratios More Important
“For most of the ‘commoditized’ big-index solutions, advisors gravitate to the ones that clearly have lowest cost, e.g., Vanguard, BlackRock, and just let the transaction costs be paid,” Kitces said.
According to him, in most cases, fees of about $9.95 or less per trade isn’t all that material for accounts that are big, as in those with hundreds of thousands, or millions of dollars in assets.
In those cases, the cost of trading is “typically made up by just picking the lowest-expense-ratio ETF over any reasonable holding period,” he said.
“If the advisor wants to buy a more ‘specialized’ ETF, they’ll buy because of its specialized role, not its lack of transaction costs,” added Kitces.
Other Factors Matter More
Kitces’ view is hardly unique. Kevin Grogan, director of investment strategy at BAM Advisors—a member of the BAM Alliance comprising some 140 independent wealth management firms—also says account size plays a role here, and that other factors trump trading fees when it comes to picking the right ETF for a client.
“For our clients, whether or not an ETF has a transaction fee tends not to be a huge factor in which ETF is selected for a portfolio,” Grogan said. “The reason for this is that we don’t trade all that much, so the transaction fee isn’t incurred very often. When we do trade, it tends to be in sizes that are large enough that the transaction fee is small in percentage terms—normally 1 basis point or less.”
So when does commission-free matter? As Grogan put it: “When we need to park cash for a period of time before we accumulate enough cash to buy [a security], we’ll use a no-transaction fee short-term bond ETF for a period of time.”
No-Commission Matters For Smaller Accounts
It also matters for advisors working with a smaller portfolio or a smaller account, where trading fees can represent a significant cost.
“The one scenario where I do commonly see advisors ‘swayed’ by no-transaction-cost ETFs is when the advisor either works with much smaller clients/accounts, where even $9.95 trades are a material transaction cost,” Kitces said.
“That could be an advisor who specializes in smaller clients, or in cases where the advisor has a ‘small accounts’ portfolio model,” he noted.
The ETF Issuer Perspective
If advisors aren’t necessarily swayed by the allure of commission-free offerings, why would ETF issuers pay up to participate in commission-free platforms?
Costs to join vary product by product, even within one issuer’s lineup of offerings, and can quickly add up to tens of thousands of dollars a year on top of basis-points-per-product offered. It’s a form of pay-to-play, with the ultimate goal of attracting assets and investor attention.
To a firm like Guggenheim, one of the issuers with the biggest number of ETFs on Schwab’s commission-free platform, the Schwab ETF OneSource—some 44 funds in all—there’s no question that participating in such a platform is good for business. But determining how good is hardly easy.
“We’ve found that advisors have gravitated to commission-free ETFs more so than [Schwab] even thought they would at the outset in February 2013,” said Bill Belden, head of ETF business development for Guggenheim. “One of the things we found is that the platform has been a meaningful opportunity to increase the visibility and value of investing in ETFs to the retail audience.”
Specifically to Guggenheim, which doesn’t market or distribute ETFs directly to retail investors, participation in OneSource has meant access to a new demographic of investors. That’s the primary “why” for joining the platform. There’s also a halo benefit of increased visibility to Guggenheim’s other products not offered on the platform.
Is It Worth It?
“It’s worth it,” Belden said. “But the degree to which it’s worth it varies by product. It’s hard to make a blanket assessment. It’s a product-by-product determination.”
Ben Fulton, an ETF expert who once was at the helm of PowerShares’ ETF efforts, and now is behind a new ETF issuer, Elkhorn, is on the fence about the whole idea.
When PowerShares first signed up with OneSource, under Fulton, the decision centered on “helping” advisors with product selection, and helping PowerShares “get to the end investor on high branded products.”
Today, however, as he leads Elkhorn, Fulton has chosen thus far to stay out of commission-free platforms, because he isn’t sure the cost issuers pay translates into asset gains.
Jury Is Out
“We were one of the first to join at PowerShares, but I've chosen not to do that so far here [at Elkhorn], and it's not because I don't like or respect the platform, but I realized if it's a good product, I don't think it matters to the advisor,” Fulton said. “The jury's still out on the assets sitting in those ETFs. Is it because of the free commission, or is it because those are widely held products anyhow?”
“I think it's going to be interesting as we start seeing some of those original contracts be renewed and renegotiated,” Fulton said. “I won't say that we won't add some of our products into those suites. But it's not a guarantee for success that, just because you negotiated that fee, all of a sudden that's going to make your ETFs successful. It's one facet of distribution.”
According to Charles Schwab, assets in ETFs offered commission-free in the platform are growing at roughly twice the pace as those not in the program.
Schwab Commission-Free ETF Assets Growing
Schwab’s data show that at the end of the third quarter, total ETF assets in OneSource totaled $63 billion, up 28% year-to-date. By comparison, non-OneSource ETF assets at Schwab, totaling $229 billion, were up only 11% year-to-date, the company says.
What’s more, Schwab’s most recent 2016 Investor Study says that “80% of RIAs surveyed say that commission-free trading is important when choosing an ETF,” and 38% say it’s “extremely important.” Among retail investors, 89% of them say that commission-free trading is important when choosing an ETF, and 48% said it’s “extremely important,” Schwab says.
The data would suggest that commission-free matters in advisor and investor decisions about which ETF to own—at least among RIAs clearing through Schwab and Schwab investors.
There are 529 ETFs offered on at least one commission-free platform:
*Interactive Brokers
Contact Cinthia Murphy at [email protected]