In the last year or so, since the growth of exchange-traded funds (ETFs) started in Asia, I’ve lost count of the number of times a financial adviser has said to me: “I know it’s good for the clients, but I can’t earn anything from selling ETFs.” So they don’t use them for investment solutions.
It’s rather sad really. If it’s good for the client but won’t get used, then clearly the client is missing out, and the advice being given is questionable.
What usually happens in these circumstances is that the client finds someone else to give better advice. It’s even sadder to learn that many of those in the fund management business now use ETFs for their personal portfolios, thus confirming their value to the total return on investment.
But the issue remains: how can you make money selling ETFs to clients?
Clearly, the reasons for using ETFs in the first place need to be understood. Generally these are:
It is the “low cost” feature that is most of concern to financial advisers. The low costs are:
With no sales charges, there is of course nothing to “compensate” the adviser. Whereas mutual funds pay up to the whole of their front end loads, ie 5%, for sales, there’s nothing for an ETF. But this means the client, as an investor, is already better off. There is no need to wait until the value of the investment has increased by the size of the load.
With low TERs the value of the assets can accumulate quicker, they don’t face the “drag” that a TER of 2%-plus can impose. But of course, from this TER there is also a commission paid to the advisory firm, often 50% or more of the management fees.
How does this get replaced, when TERs on ETFs are less than 1%?
It needs to be remembered that ETFs are not the “exclusive investment solution”, but merely form a part of the recommended portfolio. Thus, it is part of the answer, not the whole answer, to investing.
The key to making money on using ETFs with clients is as follows:
1. Turnover – most ETFs are set up to allow immediate purchase and sale on the stock exchange where they are listed. As a result, they can be actively traded, just like any other stock on the exchange. The result is that many of the most popular ETFs are among the most actively-traded listings. Each trade (in Hong Kong at least) incurs a 0.15% brokerage charged by the stockbroker. Thus, for a client that has, say, made a purchase of ETFs, if this is turned over five times in a month, for example, that’s 10 trades, which will earn 1.5%. Maybe the client is less active, and just does four trades a month, that is still 48 trades in a 12-month period, equal to 7.2% of the original amount invested, in stock brokerage commissions.
2. More money – a lesson learnt in the US on using ETFs with clients is how they have tended to attract more money to an account than had been expected. Indeed, the leading broker/dealers in the US often use ETFs as a “loss leader” to attract assets, by offering a “no commission deal” for new money and the first few trades. The result they have experienced has been a massive growth in the total assets received for management from their clients. As many of these accounts also charge “asset-based fees” the enlarged AUM achieved has proven very profitable.
3. New clients – satisfied clients are always the best sort. Those that feel they are getting a good deal from their adviser will invariably tell their friends, thus increasing the numbers of clients for whom the adviser is acting.
Yes, at first glance, ETFs don’t seem to offer much for financial advisers that seek revenue from the advice they give, but in reality the opposite is in fact the case.
Going forward, as more and more places are either putting a ban on commissions from sales of financial products, or are insisting on disclosure of commissions, it can be expected that the use of ETFs as part of the investment solution for clients will increase substantially.
Please note: views and opinions expressed in this article reflect the views and opinions of the author only and are not necessarily shared by Citi. The views and opinions expressed are not intended as, and should not be taken as, advice or inducement to buy, sell or otherwise trade any securities.