In the last month, we have seen an old fashion pricing war between brokerage giants across the industry. Things kicked off in late September with Interactive Brokers and the introduction of IBKR Lite, followed by Schwab, TD Ameritrade, ETrade and most recently Fidelity moving to zero commissions on all U.S. stock and exchange-traded fund (“ETF”) trades.
The initial news sparked positive reactions from your average investor. Zero commissions for stocks and ETFs, what could possibly be wrong with that?
After the dust has started to settle, it got us thinking about the future of wrap fee programs and custodial partnership due diligence.
Below we discuss both elements to get you thinking as well:
Wrap Fee Programs
A program that investment advisors once utilized to offer their advisory services for a single combined fee, now has a new wrinkle. As you have heard from us many times, part of an investment advisor’s fiduciary duty is to recommend services that are in the best interest of the client. Given the industry shift to no transaction fees for stocks and ETFs, if you currently offer a wrap fee program to clients where you charge a higher advisory fee to take into account transaction costs, have you asked yourself if wrap fee programs really are in the client’s best interest?
It is our belief that regulators will be asking you this question the next time you are visited. Historically wrap fee programs have been scrutinized by regulators to ensure their appropriateness. Specifically, under the microscope were reverse churning and high cash balances. Zero commission on certain securities will certainly draw the attention of examiners as they determine if a wrap fee program is in a client’s best interest.
If you sponsor or recommend the use of a third party wrap fee program, we strongly urge you to conduct a review of the underlying investments utilized to build client portfolios. Items to consider include:
- What is the composition of underlying investments in the wrap fee program (percentage allocated to stocks, bonds, ETFs, mutual funds, options, etc.)?
- Do you primarily invest in individual exchange-traded securities such as stocks and ETFs?
- Do you primarily invest in mutual funds and if so, are they generally transaction fees or no transaction fee funds?