The recent setting aside of the broker-dealer exemption rule could make the brokerage community one of the hottest markets for exchange traded funds — a dramatic reversal from the way ETFs were viewed by brokers just a few years ago.
PHILADELPHIA — The recent setting aside of the broker-dealer exemption rule could make the brokerage community one of the hottest markets for exchange traded funds — a dramatic reversal from the way ETFs were viewed by brokers just a few years ago.
To a large extent, the change in mind-set already was under way — thanks in part to the shift from commission-based to fee-based brokerage platforms.
Now, as brokers face moving billion of dollars from fee-based accounts into advisory accounts, the ETF industry is shaping up to be a big winner, said Charles “Chip” Roame, managing principal of Tiburon (Calif.) Strategic Advisors LLC.
That is because ETFs are a perfect fit for advisory accounts, he said.
If a brokerage firm is going to run an advisory program and charge a 1% fee for advice, it behooves it to use the lowest-cost investment vehicles it can find, and in most cases, those vehicles will be ETFs, Mr. Roame said.
And ETFs offer brokers a certain amount of regulatory protection, he added.
When regulators come “sniffing around” to make sure everything is in order, it will be hard for them to argue with low-cost ETFs that provide diversified exposure to the market, Mr. Roame said.
All this appears to be good news for ETF providers.
The brokerage community is “the single-largest focus for our business today,” said Anthony Rochte, a senior managing director with State Street Global Advisors of Boston, the second-largest ETF manager in the world with $101 billion in ETF assets under management.
San Francisco-based Barclays Global Investors, the world’s No. 1 ETF manager, with $285 billion in such assets, did not make executives available to comment.
Wider acceptance?
But not everyone is convinced that ETFs are on the path to finding widespread acceptance among brokers.
Until brokers are compensated as well for selling ETFs as they are for selling mutual funds, ETFs will always take a back seat, said James Pacetti, president of ETF International Associates Inc., an industry consulting firm in New York.
“I think the problem ETFs have always had in the brokerage community is that they don’t pay for distribution,” he said. “That problem hasn’t gone away.”
That may be the case, but there are signs that the problem is abating.
ETFs were a popular option within the advisory-account program at Wachovia Securities LLC of Richmond, Va., before the court decision vacating the broker-dealer exemption rule, said P. Michael Jones, a managing director and chief investment officer at the firm.
That’s because brokers with clients in Class C shares of mutual funds already had started forgoing those investments in favor of ETFs to avoid regulatory scrutiny, he said.
Also, some brokers already had formed the opinion that advisory accounts with ETFs are the perfect rollover vehicle for retiring baby boomers.
Indeed, dollar cost averaging — a major stumbling block for investors in 401(k) plans because of the trading costs it entails — isn’t an issue in advisory accounts, because brokerage firms that offer such accounts use their leverage to lower, or even eliminate, trading costs, said Lloyd Raines, a financial consultant in Stamford, Conn., who is associated with RBC Dain Rauscher Inc. of Minneapolis.
As further proof that ETFs are finding favor among brokers, The Consulting Group, a Wilmington, Del.-based division of Smith Barney, in April launched eight model portfolios that invest in exchange traded funds called CG Select ETF Allocations.
Officials at Smith Barney, the brokerage unit of New York-based Citigroup Inc., could not be reached for comment.
But that venerable firm’s move into ETFs is not unusual, SSgA’s Mr. Rochte said.
‘Game change’
Today, there isn’t a major brokerage firm in the country that isn’t at least considering a similar move, he said.
It’s why when SSgA went through reorganization earlier this year, it made sure to assign six wholesalers to the brokerage channel, Mr. Rochte said.
There’s no doubt ETFs represent a “game change” for the industry, Mr. Jones said.
“Asset management firms need to have an ETF strategy,” he said
But even though ETFs already were gaining acceptance in the brokerage world, Mr. Jones said, the absence of the broker-dealer rule may help ETFs gain acceptance.
