ETFs for High-End Wealth Management

On October 1, Barclays Wealth Management (BCS) in the Americas launched eight ETF-based portfolios for clients with assets of $10 million or more. The portfolios will allow large clients to open small, diversified accounts, such as those for their grandchildren.

This small change continues the shift in wealth management towards low-fee, passive products. Although Barclays will actively manage the asset allocation mix, these portfolios will have lower fees, so the development is bearish for banks with large wealth management businesses. Shareholders of Citigroup (C) and Bank of America (BAC), take note.

Costs are lower with the new mix. After HSBC (HBC) launched a similar effort, its asset management fees dropped to 25 basis points from a range of 50-100 basis points. That's a big hit to revenue.

Will passive funds become a mainstream vehicle for the super rich? Last week Barron's offered a special report on ETFs and the ways that investors are using them. ETFs fit well into a "core and satellite," though wealth managers differ in whether or not ETFs should form the core or the satellite. The difference in investment philosophy often reflects their existing business model.

Indeed, compensation for wealth managers is often the driving force behind investment recommendations. Firms have deep vested interests in their fee structures, and in the product mixes that naturally result. Most firms decry passive management and tactical asset allocation, which I have discussed in detail before.

Addressing the Inevitable

The move by Barclays acknowledges the inevitable, albeit in a small way. (These portfolios are a first step, since they are aimed at a sub-set of client wealth, rather than their core assets.) ETFs allow high-net-worth customers to execute increasingly complex strategies at the lowest possible cost, and also offer far greater transparency and tax efficiency. By using ETFs in an asset allocation product, the clients at Barclays are paying primarily for asset allocation advice, rather than for fund manager selection. Thus, an ETF asset-allocation basket would minimize the layering of fees that clients find so problematic.

This product by Barclays addresses a frequent complaint of clients: 'Why am I paying an asset management fees of 50 to 100 basis points when my wealth manager has outsourced all of the money management to a third party?''

Core and Satellite

This offering by Barclays does not mean that high-net-worth clients are not seeking alpha, or that clients are unwilling to pay for performance. Far from it. Instead, clients want to get market exposure at the lowest possible cost, which can be done via passive strategies. ETF portfolios could be complemented by alternative assets and mutual funds (using only a select few managers who demonstrate consistently high risk-adjusted alpha). I believe that ETFs will eventually become a default choice for basic asset allocation purposes, while actively managed funds will be the "icing on the cake."

Barclays would be wise to position the new ETF portfolios as part of a "core-and-satellite" approach. An ETF portfolio entails minimal compliance costs, and Barclays already does asset allocation research. Thus, the firm could spread its existing research costs over a larger asset base and offer this product for as little as 20 basis points. Although the fees are lower, since the research and compliance costs are minimal, margins could still be quite attractive. (A passive "core" strategy would also allow the financial advisor and the client to focus on the "satellite" portion of the portfolio, where alpha generation occurs.) I can see the talking points now: 'Pay just 20 basis points for an ETF core portfolio, and pay 1% for a satellite portfolio of alternative assets.'

Paying for Alpha

This shift embraces the inevitable reduction in fees, but does not throw in the towel on active asset management. Indeed, by combining ETFs with the firm's asset allocation strategy, Barclays can turn the abstract realm of global asset allocation into a concrete, actionable product. In addition, the firm has a high profile in the ETF business, due to the iShares business they are selling to BlackRock. If Barclays plays its cards right, these ETF portfolios could be a blockbuster, and not just because of low fees.

ETFs and Volatility

After a year of unprecedented market volatility, clients place a higher value on liquidity than ever before. ETFs are priced intra-day and do not have penalties for early redemptions, unlike mutual funds. ETFs do not "lock-in" a client to any given strategy, and the asset allocation can be tactically adjusted quite rapidly. This makes them ideal vehicles for tactical asset allocation.

In order to be truly successful, Barclays must be willing to use ETFs from any provider. Now that Barclays is selling their iShares business to Blackrock, the firm should be free from any conflict of interest when choosing passive products. Thus, they can execute their asset allocation strategy strictly for the benefit of their high-net-worth clients. (Easier said than done. Conflicts of interest are rife in the wealth management industry.)

All in all, the launch of these portfolios at Barclays continues to move wealth management away from high-priced bundled offerings toward passive products that entail lower fees. By shifting the focus to active asset allocation, firms like Barlays are turning passive, low-fee lemons into actively managed lemonade.

Disclosure: No position in stocks mentioned. Although I worked at Barclays in the 1990s, I have no ties to the firm or to any ETF provider.