The Baffling Union of Financial Engines and the Mutual Fund Store

Financial Engines offers low-cost portfolio solutions, so how will its newly announced acquisition of the high-cost Mutual Fund Store fit in with that?

The $560 million acquisition will add roughly $9.8 billion assets under management to the $104.4 billion Financial Engines had under management at the end of 2014. CEO Larry Raffone said this "is not a brick-and-mortar play," but rather an acknowledgement that "people want help in different ways.”

With Nobel laureate William Sharpe as one of Financial Engines’ founders (and current board member), I’ve always viewed the company as an advocate of low-cost passive investing. Indeed, Sharpe’s paper, The Arithmetic of Active Management, neatly proves the futility of high costs. With nearly $900 billion in assets under contract, its revenue as a percentage of assets is under 0.04% annually, according to my estimates. Even on the $104.4 billion it manages, it still comes out to be about 0.25% annually, or similar to most low-cost robo advisors.

The low fees charged by Financial Engines are in sharp contrast to fees charged by the Mutual Fund Store. Looking at several form ADVs, I found fees ranged from 0.90% to 1.50% annually of assets, depending on the size of the account. That may explain why Financial Engines is paying over 31% of its current market capitalization for only an additional 9% assets under management. It’s buying far more profitable assets and a vehicle to grow those profitable assets.

I don’t know for sure what is really driving this acquisition, but Financial Engine’s stock price has been beaten up over the past two years, declining by roughly 50%. While revenue and net income increased, it apparently didn’t do so as fast as investors expected.

Perhaps Financial Engines is turning away from its academic roots of low fees and belief in efficient markets. Perhaps the drive to create shareholder value has outweighed the drive to create value for clients.

Sharpe wouldn’t be the first famous financial academic to vary from his academic work, as Burton Malkiel seems to have taken a long, non-random walk down Wall Street with his launch of the USA Mutuals/WaveFront Hedged Emerging Markets Fund with annual fees of (gasp) 1.5% to 2.5%, depending on the share class.

While only time will tell what Financial Engines plans to do with the Mutual Fund Store, for the time being, I remain more than a bit concerned that this will not be good for investors.

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Allan S. Roth

Founder, Wealth Logic

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