The Friday Insider: Wall St struggles to adapt to lower fees

This is the first edition of what will be a regular, weekly series I’m calling the Friday Insider.

My goal is take headlines from the financial news and give you a quick ‘behind the scenes’ explanation.  The headlines are often biased or filled with jargon, hopefully I can simplify and put things in real terms, terms that mean something to you.

Morgan Stanley Drops Vanguard Mutual Funds

A few months back I wrote an article about the new fiduciary rule and the battle around it raging on Wall Street.  The fight continues, and with this story, has reached the spiteful stage.

Vanguard, an industry colossus known for their ultra-cheap investments, was told to ‘get out’ by Morgan Stanley, an industry colossus…ummm, definitely not known for their ultra-cheap investments.  Morgan Stanley cites their ‘goal was to close out under-performing and less popular funds.’  Hmmmmm.  Here’s a quick look at fund flows, literally where money is moving, for 2016:

As you can see in this chart from Morningstar, Vanguard absolutely dwarfed the rest of the business in net flows, it’s not even close.  Does this look like a case of ’less popular funds’ to you?

The real story, the one that Morgan Stanley won’t put in any press release, is Vanguard refuses to pay to play.  They won’t make ‘shelf space’ payments to Morgan Stanley, or any other firm, something the other fund companies do willingly to get access to Morgan Stanley’s huge salesforce.  Morgan Stanley decided not to play around anymore, and is simply taking their ball and going home.

What’s important here is what it says to the client with real dollars to invest.  Morgan Stanley is telling you you’re not allowed to have certain investments.  For reasons that, if taken at their word, are at best confusing, they are restricting client access.

The lines in the low fee/high fee battle could not be much clearer, and Morgan Stanley is making a huge wager that their clients aren’t paying attention.

Fund Firm Fires Boss in Purge

AXA, a large financial services firm out of France, fired Peter Kraus, CEO of its AllianceBernstein unit, along with 9 of its 11 directors.  AllianceBernstein is known as one of the old guard of Wall Street mutual fund companies, charging high fees for actively managed mutual funds.  In 2007, AB managed over $800 billion.  Today that number has dipped below $500 billion.

Last year Kraus gave an interview with Bloomberg where he said “it’s pretty clear that active managers have not performed above their benchmarks in any great degree, and we as an industry really have to take a look at that and say what are we doing that’s not fitting the bill.”  In other words, they were charging their clients high fees and not really rewarding them with high performance.  Here’s a look at how their funds did against their benchmarks, these numbers again courtesy of Morningstar and Nir Kaissar at Bloomberg:

I checked on the cost of these funds:  the range goes from 0.64% to 1.11%, and these are institutional share classes, which means the typical client will pay much more than that.  To add insult to injury, the best performing fund from the above chart is the cheapest, and vice versa.

Whether he was fired for pointing out the flaws in the business isn’t clear, but I’d bet it’s no coincidence.  Mutual fund companies have been slow to adapt to the overwhelming trend of clients seeking cheaper investment solutions.  These firms have a clear choice:  adapt or die.  The flood isn’t coming, it’s already here;  here’s guessing the higher ups at AXA didn’t appreciate his airing their lack of an ark-building strategy.

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