The costs involved in distributing retail investment funds have risen significantly because of a change in the transaction fee structure, and also as a peculiar consequence of increased competition and choice.

When Andrew Rogers, chief executive at Gemini Fund Services, had word from broker-dealers selling his company mutual funds that the cost of servicing accounts would change from the usual per-transaction fee to 10 to 15 basis points per account, the switch resulted in doubled costs.

“The lack of trading volume and the growth of exchange traded funds has squeezed the revenue of custodial platforms, such as NFS, TD Ameritrade and Schwab,” says Mr Rogers. “We’re faced with a different business model.”

It used to be that when financial advisers sold a 2 per cent load mutual fund to a client, the fund manager secured a full 1 per cent on the transaction, while the financial adviser and distributor split the other 1 per cent.

“Under the new model, more of the 2 per cent is going to the adviser and distributor because of the growth of passive funds. It’s a redistribution of wealth,” says John Rekenthaler, vice-president of research at Morningstar. “The growth of passive funds with their lower expense ratios is challenging actively managed funds.”

Increased competition is also causing distribution costs to creep up at large wirehouses, such as Merrill Lynch, Morgan Stanley and UBS. Before the collapse of 2008, many of these companies exclusively sold only in-house mutual funds.

“These in-house products still exist but financial advisers today want choice, and the implication of offering choice from the wirehouse’s point of view is increased competition,” says Mike Papedis, executive vice-president of business development at Hightower, a national partnership of financial advisers in New York.

“That increased competition cuts into making a fat margin from only selling proprietary products.”

At Fidelity Financial Advisor Source, the fund management fee for a large-cap passively managed ETF or index fund currently is 5 to 15 basis points compared with 50 to 75 basis points for a large-cap mutual fund management fee.

Scott Couto, president of Fidelity Financial Advisor Solutions in Boston, says: “We work with intermediaries, such as Morgan Stanley, Merrill Lynch, Wells Fargo, Raymond James and LPL.

“Over time, we’ve noticed that the expenses associated with getting access to their systems have increased because they are providing an environment in which their advisers are well trained and have access to great resources and tools.”

Annual expenses per year for Schwab, Vanguard and Fidelity passive stock funds tend to be 10bp to 20bp, compared with 70bp to 110bp for actively managed stock mutual funds, according to Morningstar.

With the shift towards fee-only advising well under way, financial advisers have too many options to be concerned with rising distribution costs.

Charlie Epstein, a Holyoke, Massachusetts-based financial adviser, says: “We’re not feeling the pinch that wirehouses and mutual fund manufacturers are experiencing.

“But if it did trickle down we’d shift to another fund family unless there was enough of a return to cover that extra distribution cost, especially when ETFs are trading so inexpensively.”

Noah Hamman, chief executive of AdvisorShares, adds: “Because of declining growth from mutual funds and increasing growth in ETFs, we believe broker dealers, such as Schwab and Fidelity, will eventually look for opportunities to generate income from ETF listings, which can ultimately increase costs for ETF sponsors.”

According to Lipper Annual Money Flows, $10.8bn moved into ETFs compared with $7.5bn into stock mutual funds for the week ending January 9, 2013.

Another reason for the higher distribution costs is the increased amount of compliance asset managers need to put in place.

Chuck Miller, managing partner at Carlton House Capital in Chicago, says: “It can take up to six to eight weeks to get a response from compliance to review and approve marketing materials created for financial advisers. Reviewing and approving requires time and staff, and you have to compensate the staff. These costs are being absorbed by the mutual fund company.”

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