Your investment advisor has a problem — you’re not paying them as much.
According to a note from JP Morgan’s Kenneth Worthington, Charles Schwab is seeing a significant switch from mutual funds to exchange traded funds (ETFs) that is crushing their fees and revenues.
Charles Schwab is a huge asset manager. The firm had around $2.5 trillion in assets under management in 2014, so it’s not unreasonable to view it as a bellwether for the broader sector.
“We show that Mutual Fund OneSource AUM has been on the decline, from $260bn in 4Q14 to $207bn in 4Q15 (some accounting differences make the comparisons not quite apples to apples),” said the note. “While Mutual Fund OneSource is shrinking, ETF OneSource is growing smartly, although off a very small AUM base, currently standing at $16bn of AUM.”
The problem for advisors with this shift is that mutual funds typically charge more in fees than ETFs. So as more and more investors switch to the latter, fee revenue at places like Charles Schwab gets squeezed. This is huge, as fee revenue makes up 41% of Schwab’s total revenues according to Worthington.
“Fees per fee-AUM (the revenue yield in Schwab’s fee business) has been on the decline since mid-2009, falling from a peak of 50.5bps in 2Q09 to 36.8bps in 4Q15, when excluding the negative impact of money market fee waivers,” wrote Worthington.
“While there are a number of issues weighing on the revenue yield in Schwab’s fee business, we feel the growth of ETF business is having a particularly negative impact on Schwab’s revenue yield.”
Going forward, this may be a structural decline. Meb Faber of Cambria Investment Management, himself a purveyor of low-cost ETF strategies, told Business Insider this isn’t something that is going to turnaround.
“It’s a one-way street,” Faber said.
“Once you go from a high-fee, tax-inefficient structure to a very low-fee, tax-efficient structure, you don’t go back.”
And so, places such as Schwab and other asset managers have to find a way to replace these lost fees and revenue. For Schwab, that may be a pivot to its banking division. In the meantime, however, asset managers face a tough road ahead.
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