Cost-Cutting Efforts Secure ETFs’ Future
As the industry endures market volatility and the onslaught of federal regulations, the search for cost reductions has become vital.
In an interview with Money Management Executive, Stadion Money Management CEO Jud Doherty said that while he suspects the industry is generally prepared for further regulatory pressure, he expects an overall shift to ETFs will one day mitigate some of the impending industry changes.
“Mutual funds are still the dominant vehicle, but I think you will see that flip over the next five to 10 years as more people realize there’s an ETF that’s a quarter or half the cost for comparable performance in a ‘40 Act fund,” Doherty says. “The big traditional asset management firms that offer stock-picking ‘40 Act funds are scrambling right now.”
Doherty, along with the firm’s senior vice president, Will McGough, says other ways the Watkinsville, Ga.-based asset manager has found cost-cutting opportunities includes the use of new technology and the development of fully customized offerings like its managed accounts.
“We’re not going to be as cheap as Vanguard, but that’s not our value proposition,” Doherty added.
How have new regulations shaped the way Stadion approaches product development?
Doherty: There’s a lot of interesting stuff going on — everything from DoL and volatile markets, to the explosion of ETFs, and the whole robo phenomenon. I’ve been in this business almost 30 years and this is by far the most dynamic period; and that’s saying something because our industry moves very slowly. It’s fun to see those kinds of changes in our business, but it’s more fun to be at the front of them, and to have a great solution.
We developed our new retirement solution because it’s the right thing to do, versus because we said, “Hey, we need to build this to be consistent with the new regulations.” But, it has actually worked out terrifically.
In the defined contribution world, target-date funds are the default choice —they are taking in 70% of new money.
Most plans that offer qualified default investment alternatives have chosen target-date funds. I read recently that Cerulli said the target-date universe is going to go from $700 billion to $3.5 trillion by 2019, which is unbelievable growth.
I think that’s a little bit like predicting 10 years ago the broker-dealer players would quintuple in market size because they grew a lot in the years before. It’s sort of like looking at it in a vacuum that nothing better will come along, and we believe we have something better, and that’s managed accounts.
Managed accounts are a much more personalized solution. As you know target-dates are a one size fits all solution. Everybody gets defaulted into a portfolio based on their age and that’s that. Everybody is trying to differentiate their target dates, how they approach the asset allocation — Do we have alternatives? Do we not have alternatives? Active or not active? How steep is the glide path? But the reality is it’s the sea of sameness and it’s hard to say what’s the best target-date fund.
Essentially, what Stadion has built is a fully customized managed account solution where the plan sponsor can work with the adviser to come up with a custom glide path for their plan and then from there the individual participant can customize it further.
How do fee cuts from some of the larger institutions have an impact your business?
Doherty: We’re not going to be able to compete with the Vanguard target-date fund, with respect total cost of the solution, but when you consider the fact that we have an asset management fee that we apply on top of the underlining ETFs. Exclusive of any record-keeper revenue sharing that we may provide, that solution is very competitive and generally the lower cost and active target-date funds, again this is a very personalized solution for very small accounts and we’re not going to be as cheap as Vanguard, but that’s not our value proposition.
I think everybody has fee pressures — the ETF manufacturers, the asset managers and the financial advisers — everybody has got to have a solution for ultimately justifying their value and the fee that they’re charging. There’s downward pressure on ETF fees, there’s downward pressure on asset and financial adviser fees, and obviously on asset manager fees.
I may be incredibly bullish on the future of the ETF business, but today I think ETFs represent about 15% of registered products. Mutual funds are still the dominant vehicle, but I think you will see that flip over the next five to 10 years as more people realize there’s an ETF that’s a quarter or half the cost for comparable performance in a ‘40 Act fund. There are going to be more smart-beta, factor-type ETFs that completely disintermediate the active ‘40 Act funds, solely because of cost. Performance is going to be comparable so people are going to say, “Why wouldn’t they use a lower cost vehicle?”
When the DoL says they are planning on taking a deeper look into ETFs, does that create a threat for these products going forward?
Doherty: I’m not worried about that at all. I think the more ETFs there are, the better.
I mean, increased regulation is a certainty and I think everybody is prepared to deal with that. But, there’s no doubt in my mind that everybody that manages a traditional mutual fund is very actively looking right now about how they are going to live in an ETF, lower cost world, and they’re trying to figure out how they are either going to convert their ‘40 Act funds to ETFs, or how they will create an ETF business line, or how they can acquire an ETF manufacturer, for instance. The big traditional asset management firms that offer stock-picking ‘40 Act funds are scrambling right now.
At Stadion, our belief is that the retirement industry has an accumulation problem. I continue to read about the distribution phase, the payout phase, the retirement phase, and I have a strong believe that people just aren’t saving enough and our primary objective in our retirement business is to get people to save more and hang on. You get them to hang on by giving them an investment experience that’s comfortable with their personality and you can’t do that with a target-date fund.
In the save more piece of it, I don’t care if you can get a 3% payout on your rollover or a 15% payout. If you only accumulated $30,000 for retirement it’s not going to matter. It’s our job to get people to contribute significantly more, save more, and build a much more significant nest egg so now the distribution conversation matters.
What is your firm’s stance on robo technology?
Doherty: It depends on what you define a robo to be. If it’s using technology to deliver an investment asset allocation advice to individuals, we absolutely are a robo in the DC space. We do not, today, have an offering where you could get that for your IRA rollover, but I do think that post-DoL you’re going to have a lot of money staying in retirement plans versus rolling over just because the requirements on rollovers are tougher. So, if you have a $25,000 account balance in your 401(k), in the old days an adviser might roll that our, put it into a commission fund, collect their trail and move on, but that’s going to be harder to do. So, money is going to stay in the plan.
With that said; our service is very robo-like. We are using technology in the DC space, but I think we’re very innovative from that standpoint. The traditional robos out there — the Betterments and the WealthFronts (granted Betterment is trying to build a 401(k) product) — are trying to get the taxable accounts or the IRAs and they’re not focused on the 401(k)s yet. They are competing for the same dollars and I think we are in a niche where there is relatively less competition, but it’s also a growing market. You have got people continuing to contribute to their 401(k) accounts, and their employers are contributing to those accounts. The 401(k) is the significant accumulation vehicle, so we’ve consciously said we want to focus our efforts in the DC space.
McGough: If you think about robos too, they have mainly all been born since the financial crisis and they believe in buy and hold and diversification over the long-term. Obviously as you get farther down the time horizon you reduce your exposure via more fixed-income. So that’s where they haven’t really been tested yet even though we know buy and hold over the long term; there are arguments for and against it. That’s really where we differentiate ourselves from the pack. Our methodology is a little more dynamic with the market and we are not necessarily married an asset allocation like the robo advisers are.
What are some new products Stadion is working on?
Doherty: Over the last five years we have added several non-traditional strategies to our lineup, and again, we have a specialty of tactical and alternative in that suite. That’s really important as you think about product development.
I have a belief that we are going to see more of a barbelling of asset allocation from advisers in that on one end of the spectrum. You are going to get your core exposures at a very low cost through ETFs.
So, you would get your core equity, your S&P, your small-cap and your international exposure, and these low-cost core positions on one end of the spectrum, and on the other end of the spectrum you are going to have true diversified strategies like alternative, like tactical — they are a little bit of a higher cost, but there is true active management in there to add value. The strategies in the middle are the ones that are going to have a tough time. That can be a fundamental stock-picking strategy, but as far as Stadion is concerned, we’ve added strategies in a couple of ways.
First we have done this through acquisition. Three years ago we acquired the Stadion Tactical Growth Fund and brought the portfolio manager on board as an employee of Stadion. That strategy has been a great add to our staple. I think it was the third or fourth fastest growing tactical fund according to Morningstar last year. We had some success with that one. It has been number one ranked for five and 10 years in the tactical group, so that has been a great add to our staple. But we have also done some things organically and created some additional strategies.
We created two absolute return strategies and have had some really nice success there. One of them lives in the multi-alternative category and the other one lives in the new Morningstar option writing category. But, over the last 12 months, during some pretty volatile times, you have seen a lot of alternative strategies not do well, and that’s the time we have actually performed pretty well on a relative basis. Again, the hallmark of Stadion is we generally look pretty good when times are tough and that has proven out in the last 12 months.