ETF Stream: Everyone thinks the credit ratings agencies are a joke because their business model is too conflicted. You guys don’t have that issue to the same extent for your fund’s rating business, do you, because your clients are mostly buy-side. Is that right?
Peter Green: While our client-base for research are advisers, we do have a ‘pay-for-research’ model. Under this model, Lonsec Research is engaged by fund managers to conduct research on their financial products. This research is then disseminated to our client base, which are financial advisers.
Note that we manage this conflict by ensuring that our research team is separated from our operations team by an ethical divider. Also analyst remuneration is not linked to ratings volumes etc.
Is it mostly regulation and killing commissions that’s driving people to become IFAs?
Yes, and the fact that the big four banks haven’t had the best experience. So they’re looking to divest from wealth, which only ever made a minority of their profits anyway. A lot of the Royal Commission focussed on vertical integration and the conflicts in that so a lot of them are looking to get ahead of the curve.
The IFA model is more based on investment advice – which I totally agree with. So there are more people becoming IFAs and that’s feeding through into our changing clientele.
You guys are providing model portfolios and managed accounts. ETF providers are providing them too. I’d imagine you’re better placed to build them as you’re independent?
Again, it comes back to how the wealth management industry is changing with everyone becoming IFAs. IFA businesses tend to be pretty lean so a lot of them try to provide investments through a managed account. That then frees them up to focus on the financial advice side of things like estate planning and retirement income. So they’re increasingly looking to outsource portfolio construction to third parties.
Where we sit in the chain is we’re not aligned with a manufacturer. So we’re providing portfolios that use Lonsec research. We’re then platform agnostic because a lot of the IFAs have their own platforms.
Where do you see the role of the fee war, especially around beta 1 products?
If ETFs are simply offering beta 1 exposure then we think fees are very important and we’ll tend to go for the cheapest. Personally, I see these beta 1 products as commodities. If they’re homogenous and there is a good degree of substitutional certainty and cost is the only real differentiator then we’ll go with the cheapest.
A lot of people think ETF providers are the ultimate winners of the general asset management industry trend towards managed accounts, robo-advice, IFAs etc. Yet the providers I’ve spoken to say they’re making little money out of their core ASX 200, S&P 500, etc. ETFs.
What I’m seeing is these core ETFs are becoming more and more like loss leaders. We saw it recently with the zero fee cash ETF. The idea seems to be to get everyone in and have a good experience, build a good network which builds trust and confidence in your brand. And then hope that the network buys your higher margin products. They’re a way of building a network then building scale through that network.
From where I sit the Aussie fee war is incredibly advanced given the market is only at $52 billion. I don’t remember the US or European fee wars advancing this far until they were into the hundreds of billions.
They’re all businesses and there is no free lunch in investing. Everyone’s got shareholders and trying to meet their cost of capital.
That said, building a network can be very powerful, especially with smart beta products which will definitely have a bigger role to play in the future. IFAs’ value proposition can’t really be simple asset allocation. There has to be some kind of factor tilting so they can justify their own fees. So smart beta, thematic ETFs – not all of which will work – can and will gain scale.
In the US, most smart beta ETFs we’ve looked at are closet trackers. But advisors seem to prefer that because they don’t want to take more than market risk.
Well, there are five or six established premia in the market. If smart beta ETFs do use a systematic framework then there is room for IFAs to use them to add value for the clients.
I guess another potential benefit of smart beta might be that it makes it harder for advisors to get fired. If clients see advisors only as investment managers and see advisors, to that end, are simply running ETF portfolios they can wonder: “why do I need an advisor for this?”
Of course. And if you cast your mind out 10 years from now the reporting and benchmarking will be better, it will be critical for advisors to provide a value add somewhere else. And that’s what regulation is encouraging.
Does it get boring reviewing super similar products? I’d imagine I’d get bored reviewing A200, STW, IOZ back to back.
Well, look, we’re professionals. Sometimes things in professional life can be monotonous. But on the whole the ETF industry – and there are over 180 ETFs now – is getting increasingly varied and we’re seeing more and more differentiated products. So it’s an interesting place to be.
Peter Green is the head of listed product research at Lonsec. He will be speaking at the ETFs Down Under conference in Sydney on 16 October.