Products February 20, 2018

Fee, Share Class Shifts at Schwab and Putnam Reflect Vigorous DCIO Competition

Recent interviews with product development executives at Putnam and Charles Schwab show the aggressive steps brand name providers are taking to keep their edge in a highly competitive and unforgiving marketplace.
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Sitting down for an interview on the one-year anniversary of a major shift in compensation strategy enacted by his firm, Jonathan de St. Paer, head of strategy and product development at Charles Schwab Investment Management, presented some compelling data to show how clients have reacted to lower fees and easier decisions in picking share classes.

“It’s been one year since Schwab announced it would be eliminating all investment minimums on our market-cap index mutual funds, unifying them under a single share class, and pricing them to align with their exchange-traded fund [ETF] counterparts,” de St. Paer noted. “The simplified fee structure meant that all investors—regardless of their size—would get access to the same low prices on these products.”

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According to de St. Paer, one year out, this move has particularly benefited smaller investors in the retail and retirement spaces. Between the end of 2016 and the end of 2017, among clients with accounts with an asset value between $50,000 and $100,000, flows into Schwab index mutual funds grew significantly, from $48.5 million to $249 million; flows into Schwab ETFs grew from $544.9 million to $714.9 million.

“The numbers illustrate how fee-conscious investors and advisers have become, a development that has been a long time coming,” de St. Paer argued. “The story of falling fees is really important in 2018, but firms like ours have been focused on it for some time and we already have our solutions in place to address this new, much more fee-conscious market environment. You may remember, even before we eliminated them, our investment minimums were only $100, compared with the thousands you will see elsewhere. Schwab had already moved in the direction of a single share class on many of our products as well. This is not rocket science and the signs have been clear to us that this is the appropriate route to take. Increasingly we have seen the world of investing get more complex, so we felt it was important to offer products that reduce complexity in ways that benefit shareholders.”

It is interesting to see Schwab’s share class move prove successful both inside and outside the Employee Retirement Income Security Act (ERISA) retirement planning arena. Major changes in share class structures and compensation arrangements are two trends readers in the retirement plan space will be well aware of, but this move by Schwab extends more broadly, not just talking about products meant for retirement plans.

“The retirement space has been really instructive as we have looked at what is the best way to benefit not only DC plan participants, but end investors through other account types, as well,” de St. Paer said. “The idea of having very low cost, low entry barrier options—this is something we can deliver through greater digitization and automation. Simply put, we can manage our strategies at lower costs than we could 10 or 20 years ago, and we are trying to pass that on to all our clients. All our shareholders should benefit from the elimination of share classes on the index funds.”

Taking a step back, de St. Paer agreed that this is an “exciting and engaging time to be doing this work,” but he pushed back a little bit against the idea that change is occurring much more rapidly now in the investment management space than it has in previous decades.

“It’s funny, even if we were doing this interview 10 years ago I probably would have told you that it was a very engaging and interesting time to be in this role, because of how much was shifting and changing—and because of the opportunities we saw opening up at that juncture,” de St. Paer said. “The important point is that the rapid pace of change today has roots that go back some distance. As the pace of change accelerates with the introduction of new technology, you really have to make sure you are an early adopter and an early innovator to stay on top.”

He concluded by emphasizing again that the firm is seeing a lot of interest from smaller defined contribution plans where the adviser brings the client to Schwab, knowing that the plan won’t hit the $5 million or $10 million minimum required at another provider, but that it could hit the minimum soon. 

“The advisers really value that, as this plan grows over time beyond those thresholds, they won’t have to worry about being in the appropriate share class for the shifting size of the plan,” he explained. “They like to know that everyone pays the same low fee and that it doesn’t change if the market moves up or down.”

Putnam takes its own approach to beat the competition

Shortly following the talk with Schwab, PLANADVISER also got to sit down with Steve McKay, head of defined contribution investment only (DCIO) at Putnam Investments.

McKay as well serves in quite a broad role for his firm, covering the overall effort to create and sell a full range of products, including responsibility for product positioning, operations, and day-to-day support of all the teams running the DCIO business segment. This week, his firm is announcing its own share class and pricing innovations, these pertaining specifically to the firm’s lineup of actively managed target-date collective investment trusts, known as the Putnam Retirement Advantage Funds.

As McKay laid out, the firm is making available new “class X shares” for all vintages of the TDF suite, assessing a management fee of 0.35% for defined contribution plans that have a minimum of $5 million invested.

“The new class X shares symbolize the 10-year anniversary of the suite, which has experienced noteworthy growth in recent years,” McKay said. “Putnam Retirement Advantage Funds are designed for plan participants who want the risk/return profile of their asset allocation glide path to truly reflect their projected retirement date. The funds are actively managed by Putnam’s Global Asset Allocation team, a highly experienced group with a strong long-term track record of pursuing multi-asset investment strategies.”

Asked to put the fee announcement into the broader context of his work, McKay also suggested that conversations about falling fees are very important for 2018—yet the roots of fee compression go back quite far.

“When we first established our actively managed TDF suite this conversation was in the front of our minds, alongside our conversations about the strategy we would adopt,” McKay explained. “At a high level, we feel like, if we are going to take risk, the place to take risk is further out from the retirement date. So we take more tactical risk earlier in the glide path than the average of our peers, and then in turn as time goes by and we near the retirement date, we get steeper in our glide path than the industry average. This means that in the 15 to 20 year window prior to retirement, we try to aggressively manage sequence of return risks and land at a 25% equity exposure. The maturity portfolio is a 25% equity and 75% fixed income allocation, but it is a balanced risk portfolio, such that 50% of the risk is on the equity side and 50% of the risk is on the fixed-income side. We feel like that is the optimal portfolio in the drawdown phase.”

He emphasized this detail because, like many others, he shares the philosophy that when one talks about fees going up or down, it is important to talk about what real investors are getting for those fees. Putnam has gone down the route of actively managed TDFs, while others have embraced an indexing approach, and this naturally has a big impact on the end fee that is charged and on the client satisfaction with the performance.

“When it came to actually picking the 35 basis point number, that was actually pretty straightforward and we know that it puts us right where we should be in the mix,” McKay concluded. “We really feel like the 35 basis point figure for Class X will be one of the most competitive offerings in the active target-date space.”

The Markets February 14, 2018

Fee and Industry Shifts Mean Retirement Plan Providers Can Play Hardball

A look back at how Fidelity will charge new plan sponsor clients on its platform who choose Vanguard products makes visible the hard-nosed competition that defines the retirement plan recordkeeping and brokerage industries.
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Some weeks ago, Fidelity made the announcement that it would soon begin charging a 0.05% fee on assets invested through its institutional retirement plan recordkeeping platform into Vanguard products, including the firm’s popular suite of index-based target-date funds (TDFs) and collective trusts.

The announcement grabbed attention for some obvious reasons, including that Fidelity and Vanguard are two of the largest-volume providers of retirement plan recordkeeping and investment products for defined contribution (DC) retirement plans in the U.S.

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Fidelity has since confirmed that the nominally small fee “applies only to new clients,” but given the sheer volume of business conducted by Fidelity and Vanguard in a given year, the fee change could result in a significant amount of new revenue for Fidelity. Fidelity is still in the process of rolling out the fee on its recordkeeping platform, according to a spokesperson for the firm, so it is a little too soon to tell how clients may react. However, the firm’s salespeople may soon have more information to share, the spokesperson said.

Confirmation that the fee story is still somewhat in development/deployment comes as it was also revealed by Vanguard that this fee was announced first to journalists and only afterward to Vanguard—catching the firm “completely by surprise,” as a Vanguard spokesperson candidly admits.

A look back at the announcement

In first announcing the fee, last month, a Fidelity spokesperson indicated that working with Vanguard “imposes unique operational requirements that generate extra costs for Fidelity.” She also stressed the firm “is not removing any fund families from our platform, but we are requiring that all fund families compensate us for our services in order to remain in good standing.”

Specific to Vanguard and leading to excess uncompensated costs, according to Fidelity, is that Vanguard has a requirement that plan-level trading activity and large trade-notifications be submitted by 3 p.m. EST, or an hour prior to market close. Fidelity says this has created increased complexity for its platform and its plan sponsor clients in that “we have had to implement an earlier daily cut-off process, ensuring the trade notifications will be analyzed, reviewed and submitted to Vanguard—minimizing any trades being rejected.”

For its part, and with a respectable amount of candor, Vanguard admits it was completely caught by surprise by this move and is still, to some extent, waiting to hear directly from Fidelity about exactly how and why the fee is being implemented—and whether it is impacting clients’ choices with respect to Vanguard product. One concern for Vanguard, left unspoken by the firm in subsequent interviews but made clear enough upon a little reflection, is that the fee hike on Vanguard products will make Fidelity’s own proprietary target-date funds and other products look marginally more appealing from the cost perspective.

Fidelity plays hardball, and Vanguard’s take  

In hindsight, Vanguard’s candid admission that it only learned of this new fee through media reports, including PLANADVISER’s, is more than a little revealing of the way large retirement plan providers craft and executive their competitive strategies—and their marketing approaches. Notably, Fidelity explicitly told reporters on the day of its announcement that it “had been in conversation about this new fee for some time with [their] business partners.” Per Vanguard’s comments, it wasn’t included in the conversations, so it stands to reason that Fidelity was likely having these discussions with at least some of its own and Vanguard’s competitors.

Crucially, the secrecy of their pending move allowed Fidelity leadership to solely define the narrative of what the new fee is and represents. The original Fidelity statements stressed the point that “this is not a distribution or revenue sharing fee; this fee is for administrative services that we are not compensated for.”

Asked to talk freely about these developments, a Vanguard spokesperson suggests a few things have been misrepresented in other media reports in terms of describing the way Vanguard’s unique business operations lead to excess costs for Fidelity.

“One thing that I have seen in some of the articles is the statement that Vanguard does not pay third-party providers a distribution fee, but there is no context or explanation given for what this means,” Vanguard’s Laura Edling says. “Vanguard has a structure that is pretty much unique across the industry, by which I mean we are owned by our funds, and in turn by our clients who invest in these funds. Because of this structure, we feel that we cannot charge that sort of distribution fee to our funds due to a potential conflict of interest. If we were to pick and choose which platforms we paid in this way, it would potentially put all our investors at a disadvantage. It’s a subtle point, but it’s important.”

Another way to state the concern is that, in charging distribution fees to its funds, Vanguard essentially would be charging and paying itself for distribution.

Edling went on to question how Fidelity came to the 5 basis point fee figure, even supposing that it is losing some amount of revenue based on the way Vanguard structures its business. “I think some people may ask themselves if the size of the fee being charged is on par with what other providers might choose to charge in this circumstance,” Edling suggests. Especially when one looks at the volume of product that Vanguard sells on the Fidelity platform, she notes, even though this is a small basis point number, in the end this is a potentially significant new flow of revenue.

In the end, both Vanguard and Fidelity agree this development in the evolution of fees and discussion of provider payments is a positive thing for clients and the industry.

“We are seeing a steady drumbeat of the march towards greater transparency across the retirement plan industry, so in that respect, it is a good thing if this new structure makes it clearer what fees the participants are paying to what providers,” Edling agrees.

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