Last week, the US index-tracking giant Vanguard unveiled plans to launch a new UK business that will enable investors to buy its funds directly, thus bypassing online investment platforms and other intermediaries, such as Hargreaves Lansdown. The news sparked widespread discussion – not just in the UK but around the world – as to how the mainstream investment industry is going to compete, unless it follows suit.
Among those following the news with interest was Paul Gambles, managing director of Bangkok-based MBMG Investment Advisory. Here, he shares some of his thoughts on the matter.
The latest moves by Vanguard, the US passive fund giant, in the UK market have been heralded by the industry as “throwing down the gauntlet to high-charging rivals and financial advisers”.
While that may be true, it also leaves unanswered many key fundamental questions about end-user costs for clients.
In announcing that it is reaching out directly to investors in the UK with a cut-price offering, Vanguard is aiming to take business away from financial advisers, private banks, stockbrokers and investment platforms that it has used, until now, to reach clients (see chart, below) – despite the fact that Vanguard’s own platform is so much more limited than many of the others’, in terms of market coverage (ie, the range of assets into which it can invest, namely only Vanguard’s own funds).
Coincidentally, just before the announcement in the UK last week, I was talking to a new client about the fund giant’s offering. Since then, I seem to have been asked about it on a daily basis.
My view, and the one that seemed to prevail at a gathering of the wealth-management community here in Bangkok that took place after the Vanguard announcement, was that the reality of Vanguard’s business model, when you drill down into it, falls some way short of the hype.
Still, it has at least generated discussion on the always-timely topic of just how the wealth management industry generates its income from clients.
In my experience, there are three main types of clients:
- DIY clients, who typically make all the decisions themselves. They may pay fees for specific expertise in related areas, and also pay subscriptions or fees for research. Many might also seek to execute transactions themselves online; some may prefer to use a broker, RM or adviser.
- What I call “collaborators”, who want to be involved in the decision-making process, but tend to place a higher value on external input than their DIY counterparts.Collaborators might generally be less inclined to execute transactions themselves online.
- “Delegators” are generally investors who prefer to have a high-level overview of setting their own general investment strategy, but little or no ongoing day-to-day involvement.
The best approach is very much a client’s own decision, and can change over time. It impacts greatly on the services that are provided, and the fees that are ultimately charged for the delivery of the complete wealth advisory service.
However, this whole area is frequently misunderstood, and far from clear for a variety of reasons.
One major reason is the complexity of intermediation and dis-intermediation relationships, which appears to be changing faster today, as the role of technology increases.
In the meantime, all clients, and their advisers, face similar challenges trying to identify the most cost-effective solutions. The visible fees, that in many cases have been unbundled, are the tip of the iceberg. The majority of financial-institution profits may lurk below the surface:
Each of these have visible and hidden facets. Once having apparently ‘unbundled’ their services and fees, banks (and other financial institutions) have rather furtively buried many of them again.
Broadly, the essential links in an investment service chain comprise of the custody of the assets, the transaction of assets and the asset allocation/selection decision-making process. Investors, or their delegated agents, have to choose what assets to hold, buy and sell etc.
Visible transaction fees might amount to only a fraction of a percentage, or a flat fee per trade. But these might also be just the thin end of a fat wedge. Hidden fees can be much higher.
In addition to the fees received from genuinely third party providers, institutions frequently promote the funds of their affiliated fund management company, thus capturing, for their parent company or group, the entire up-front and ongoing fees.
There has also been a growing trend for private banks to promote structured and other products created by their investment banking division, in which product structuring has, in many cases, now become a major activity.
Structured products typically pay explicit fees (to private banks and also to advisers or brokers) which, in markets where generally such distribution fees have to be disclosed, have averaged around 2% – though they may be higher in less regulated markets.
They also generate further fees for the investment banks involved in structuring them, which can be many times greater than this.
Brokerage accounts are generally focused primarily on market-traded assets (stocks, ETFs and mutual funds etc); but they also have promoted structured products too. Within market-traded assets, there can also be additional opaque opportunities for banks & brokerages to generate significant extra income.
With the volume of US and European stock-trading taking place off-exchange, and the volumes in dark pools on both sides of the Atlantic now approaching 50%, hidden income generation at the clients’ expense is on the increase.
A wide range of choices exist to provide the most suitable services for each client’s given situation. The opaqueness surrounding these makes it difficult for clients to fully assess the best option for them.
Conflicts of interest lead to hidden or embedded fees, making the comparison of visible fees at best only a partial view and, at worst, downright misleading.
Vanguard’s initiative is definitely a move in the right direction, but its reduced offering isn’t cheap for a closed investment universe – and, like any closed or restricted universe, it inevitably compromises client outcomes in most foreseeable situations.
Therefore, the extent of savings that may be achieved, compared with most more open architecture alternatives, is the most significant metric to assess here.
As I see it, Vanguard remains more expensive than the most other competitive, restricted-architecture solutions available, and not sufficiently cheaper than the best value open-architecture solutions.
Overall, Vanguard’s UK solution also remains short of the kind of value-added extras many clients require.
At MBMG, we haven’t previously considered Vanguard’s UK platform to be the best client option on offer in the UK market, and although I’m prepared to be persuaded, I doubt that even this fee cut will be sufficient to change that.
As a low-cost index funds provider, Vanguard has outstanding marketing, even though there are often cheaper ETFs in most categories — although building a portfolio exclusively of these is unsuitable for most high-net-worth investors.
Sadly, therefore, Vanguard’s new price structure is unlikely to have any direct impact on our business.
But, just as Vanguard’s original indexing business forced change on the US and global investment landscape, it may be that the furore surrounding this latest fee cut will see reductions in custody and transaction costs elsewhere, that ultimately our clients may benefit from.
Ideally, it will start a broader discussion about how conflicts that still pervade the investment profession, to the detriment of end-users, can be addressed, leading to transparency regarding all fees.
Otherwise, at least we’ll have cheaper explicit fees, and have to continue doing our best to hunt down those hidden costs.