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

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.”

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.”