While assets under management (AUM)-based fees are still norm in the exchange traded fund (ETF) strategist industry, a new entrant is aiming to rock the boat with a line of capped-fee portfolios.
Scott MacKillop, the former president of Frontier Asset Management, has launched a new ETF and mutual fund strategist shop, offering capped-fee separately managed account (SMA) and model strategies.
His new venture, First Ascent Asset Management, offers strategic SMAs and model portfolios composed of ETFs and mutual funds, called Global Explorer portfolios. For non-discretionary models, the firm charges 25 basis points of assets under management capped at an annual fee of $1,000, according to a regulatory filing. For discretionary SMAs, the firm charges 50 basis points of AUM, capped at $1,500.
That means that after a model account reaches $400,000, or an SMA reaches $300,000, fees won’t increase for higher levels of assets under management. A $1 million SMA account, for example, would be paying a fraction of a basis point, at $1,500 a year.
“The whole industry is working on an AUM basis, and that doesn’t really make very much sense,” MacKillop says. “So we thought we could step in and do something dramatically different and hopefully generate a pretty good flow of assets.”
While a few ETF manufacturers have declined to charge a fee for packaged strategist portfolios, because they are paid instead from the expense ratios of the underlying funds, most open architecture strategists using third-party funds charge a fee based on assets under management – the norm in the broader asset management industry.
MacKillop says the traditional approach of charging clients based on AUM doesn’t makes sense, pointing out that the costs to the manager don’t necessarily increase when assets under management do.
“The assets under management fee schedule just didn’t seem to make any sense,” MacKillop says. “There’s no more cost to us managing a million-dollar portfolio or a $5 million portfolio, than a $500,000 portfolio. The whole logic of [AUM-based fees] just seemed wrong. It seemed to penalize larger accounts.”
MacKillop says he opted to outsource many middle- and back-office systems, and draw heavily on technology to keep down internal costs. That in turn has allowed him to offer the strategies for a lower fee.
“That’s given us the opportunity to have a pretty nontraditional fee schedule,” MacKillop says.
Eventually, First Ascent may take its approach to capped fees even further, by charging all accounts a flat fee, according to a statement from the firm.
This comes at a time when regulations, such as the Department of Labor’s (DOL) fiduciary rule, and the rise of robo-advisors, has heightened attention to fees.
Fee-pressure is building up steam across the industry, says Dennis Gallant, president of GDC Research. While this poses competition and may result in lower margins for asset managers, it can also be an opportunity, he says.
“There’s going to be much more competition over cost,” Gallant says. “A lot of firms are trying to get ahead of that curve to come out with solutions that are low-cost.”
MacKillop expects that the capped fee structure may be a competitive advantage and may help him land large accounts.
“Usually when we’re talking about a lower fee, people assume you’re talking about going after small accounts,” MacKillop says. “We’re certainly happy to take the small accounts, but when you think about it, based on our pricing structure, we would be most appealing to large accounts.”
MacKillop says his firm will compete most directly with firms providing strategic ETF-based portfolios intended as outsourced solutions for advisors, such as Loring Ward, Brinker and SEI.
First Ascent’s portfolios themselves employ a core-satellite approach, using passive ETFs for the core, with a few active mutual funds as satellites.
First Ascent is focused on marketing these to independent advisors in the independent registered investment advisor (RIA) and independent broker-dealer channels. The firm has already landed on the Envestnet platform and is currently in talks with additional distributors, MacKillop says. The strategies have been seeded and running since the beginning of the year and have about a five-month track record, and so far hold about $1.6 million.
The rise of low-cost robo-advisors and the regulatory environment have added a lot of visibility and pressure to manager fees, says Tim Welsh, president of Nexus Strategy.
“The beauty of the asset management business is the basis points you get on a higher net worth portfolio. The greater the net worth, the greater the profits,” Welsh says.
The fact that a manager is willing to give up the extra basis points that come from large accounts with an AUM based fee is a sign of the times, Welsh says. “They’re willing to give up that profit in order to make it up in terms of volume.”
“Ten years ago this never would have happened,” Welsh says. Now, because of the availability of robo advisors and their low cost investment pricing that’s more visible, you will start to see this more and more.”
While capped fees may generate interest, ultimate success of the portfolios will likely depend on building a track record of strong performance, says Gallant, the strategic consultant.
“There is an opportunity for a lot of new [low-cost] entrants in the marketplace, but you still have to compete with performance,” Gallant says. “Advisors are always going to be cautious.”
The firm’s launch also comes after a contraction in broader ETF strategist industry, as several tactically-oriented strategists bled assets. ETF strategist assets tracked by Morningstar had fallen to $73 billion at the end of 2015, down from a peak of $103 billion in the first quarter of 2014.