Mar 27, 2018

How Advisors Can Hold on to Their Clients Despite Vanguard's Broadening Reach

By Joe Duran

During a February speech, Vanguard CEO Tim Buckley said 58% of most advisers' work could eventually be done by computers. This would force a significant change in pricing for most in the industry. Shortly thereafter, Vanguard announced it would create factor-based index ETFs. These two events are directly linked and help explain why one of the bastions of low-cost, passive index investing is now launching ETFs that are more expensive and active than the products that made them so successful.

Just two years ago, Vanguard Group launched its Personal Advisor Services, which offered clients a personal planner at an incredibly low cost. It was one way to increase revenues from clients. The service rapidly ballooned into one of the largest wealth management offerings in the nation. Now that it has successfully climbed vertically in the service stack, it makes sense for Vanguard to broaden its product offerings. Such a move provides the company with very tangible benefits.

1. Averting the race to zero. What Vanguard pioneered in low-cost index investing has radically altered the investment landscape, and we are in the midst of a race to zero. Competition keeps driving down the internal cost of index products and, by extension, all investments. At the current cost of 9 basis points, the average Vanguard ETF cost disclosed on its website, every additional drop of 1 basis point is a 12% reduction in revenue. Vanguard started the price war, and it needed a differentiated product to generate offsetting revenues. Factor-based index ETFs are its answer. The internal costs are about the same, but Vanguard can charge fees that are significantly higher (and far more profitable).

2. Broadening market share. While many investors appreciate the value of passive index investing, a broad swath of people want something more unique. Factor-based index solutions appeal to many folks, especially those who work with advisers. Funds and ETFs from firms like Dimensional Fund Advisors (the pioneer of factor-based investing) and BlackRock Inc. have grown successfully by positioning themselves as enhanced index alternatives. Vanguard has taken notice and wants access to those clients, either directly or through advisers.

3. Climbing up the value stack. It's no secret that Vanguard's foray into planning has been a massive success, reaching $100 billion in AUM in a couple of years. Providing an adviser and planning to clients for 30 basis points is an industry changer, but not very profitable. By adding a broader array of investment alternatives, Vanguard can offer services and strategies to clients in a way that competes directly with investment advisers. In addition, it makes higher margins from its investment solutions to subsidize its PAS cost structure.

Another assault on the independent adviser

This is a winning strategy for Vanguard, but it is also an addition to the long list of threats to the independent adviser. Many advisers believe they can beat Vanguard's offering because it is limited to passive indexes. Obviously, that's no longer true. Independent advisers who want to maintain their pricing will need to take on a three-pronged strategy:

1. Understand your clients better than anyone else. The one thing Vanguard will struggle to do is forge meaningful bonds with any of its clients. One of the biggest competitive advantages any adviser has is the ability to be deeply connected to his or her clients and be more responsive and specific to each client's needs. People's lives evolve and their needs change. It's very hard for a firm of Vanguard's size to match the kind of intimate knowledge and service an independent firm can provide.

2. Offer low-cost investment solutions augmented by highly specialized complementary strategies. Even though Vanguard is broadening its portfolio choices, the company is still constrained by its narrow suite of solutions. If clients want a laddered bond portfolio or a tax-managed index of individual stocks, they won't find it at Vanguard. People appreciate options tailored to their specific financial life goals. Independent advisers can craft bespoke investment solutions for their clients.

3. Provide specialized guidance and planning services. In order to provide scale and deliver low cost planning, Vanguard relies on unsophisticated planners and a simple, predictable set of circumstances. That will change as it brings on more financial planners. But in the meantime, the ability to deal with more complex situations that might transpire in a family's lifetime is still a potential competitive advantage for independent advisers.

Living in a world of co-opetition

Vanguard is looking both to augment its client solutions with more profitable products and appeal to independent advisers to use its funds. Whether you view Vanguard as a friend or a foe, don't make the mistake of ignoring its strategic shifts. Evolving your firm to provide a distinct and unique client experience is the best way to thrive regardless of where the industry goes.

This article originally appeared on Investment News “Duran Duran” blog.

Joe Duran

Joe Duran

United Capital Financial Advisers, LLC (“United Capital”), is an affiliate of Goldman Sachs & Co. LLC and subsidiaries of the Goldman Sachs Group, Inc., a worldwide, full-service investment banking, broker-dealer, asset management and financial services organization. Investing involves risk and clients should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.

The information contained in this blog is intended for information only, is not a recommendation, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances. This blog is a sponsored blog created or supported by United Capital and its employees, organization or group of organizations. This blog does not accept any form of advertising, sponsorship, or paid insertions. Certain authors of our blog posts may be influenced by their background, occupation, religion, political affiliation or experience. It is important to note that the views and opinions expressed on this blog are that of the owner, and not necessarily United Capital Financial Advisers. As a Registered Investment Adviser, United Capital does not allow any testimonials on their blog, and any comments deemed as such United Capital will remove.

United Capital does not offer tax, legal, or accounting advice; therefore all articles should not be taken as such. Readers should obtain their own independent legal, tax or accounting advice based on their particular circumstances. All referenced entities in this site are separate and unrelated to United Capital. Any references to any specific commercial product, process, or service, or the use of any trade, firm or corporation name is for the information and convenience of the public, and does not constitute endorsement, recommendation, or favoring by United Capital.