Why index-fund fever did not wash over Wall Street brokers

Figures suggest that brokers have a far smaller percentage of client assets in passive funds compared to the larger industry

Why index-fund fever did not wash over Wall Street brokers

There’s no mystery behind the popularity of passive funds, especially given their lower cost compared to active funds and the heady returns offered by the stock market in recent years. What might surprise some is that the trend isn’t catching on as strongly within a certain segment of the investment-fund industry.

Citing a 2019 survey of U.S. advisers and brokers conducted by Cerulli Associates, Wall Street Journal contributor Randall Smith said that brokers at Wall Street firms have only 29% of their clients’ managed-fund assets in passive index funds, compared to 45% among independent investment advisers.

“The gap is even wider for regional and independent brokerage firms, which have smaller average account sizes and passive percentages of only 22% and 20%,” Smith said.

Are fees the X-factor?

The difference, experts say, comes down to how brokers and advisers generate revenue for themselves. According to securities-industry experts, Wall Street has historically clung to a sales-oriented culture, with brokers hoping to impress clients through skillful money-manager selection.

Certain brokers and firms also stand to get paid more in commissions and other compensation from active funds. Cerulli said that commissions account for 32% of big-firm brokers’ pay and between 40% and 41% of that of brokers at smaller firms, compared to just 5% of payment for independent advisers.

Critics also argued that independent advisers work under a fiduciary standard that many say inclines them toward passive investment products, compared to the suitability standard for brokers who may recommend active funds with higher costs and potentially worse performance.

Read also: Active funds show signs of a comeback

Bing Waldert, Cerulli’s managing director in charge of research, told the Journal that passive percentages among big-firm brokers have risen markedly compared to what they were a decade ago. Even compared to last year, when they had just 24% of clients’ assets in passives, their current allocations are noticeably larger.

The case for active

Advocates for Wall Street, meanwhile, explained that brokers may sometimes favour active funds to provide added value. While they may acknowledge the difficulty in beating the index, clients with certain goals and risk-tolerance thresholds may want to nonetheless chase the opportunity to get market-beating performance.

“Morgan Stanley Wealth Management has found that in many cases active management may help investors improve their risk-adjusted returns,” wrote Morgan Stanley investment strategist Dan Hunt in a March article on the company website. This is true particularly when markets behave treacherously, he argued, reflecting a view held by many brokers and active-fund advocates.

When asked to comment on the Cerulli numbers, Wall Street executives told the Journal that active funds can be a key player in successful investment strategies. Passive fund investing alone, they added, doesn’t indicate adherence to fiduciary standards.

Others argued that the wide menu of top active funds can be a big draw for clients of big brokerage firms, and that active funds with commissions could still work out cheaper in a buy-and-hold brokerage account without an annual fee than index funds in an account held with an investment advisor that charges an annual fee.

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