Bloomberg published an excellent article about the conflicts of interest that exist among the big banks which are rolling out and promoting robo-advisor programs for their wealth management clients. If you plan to use one of these robo-advisor programs, you should be aware that you are probably going to be placed into funds and ETFs which are probably not in your best interest to own. Instead, the investment decisions will be driven in no small part by the compensation that these banks are receiving from various fund companies.
Robo programs could favor mutual funds and exchange-traded funds from companies that make such payments, according to disclosures by the banks. The practice is known as revenue-sharing, or paying for shelf space. It includes sponsoring conferences for bank employees at luxury resorts and lavishing top brokers with gifts and entertainment.
Conflict of Interests: It’s Not Just a Robo-Advisor Problem
While the Bloomberg article addresses the conflicts of interest at some robo-advisors, it’s important to keep in mind that the conflicts that exist at these brokers also pertain to their large staff of warm-blooded human financial advisors.
If you work with a financial advisor who is registered as a broker, you should be aware of these conflicts.
The conflicts of interest described in the article are unrelated to whether you are working with a person or a computer; they are related to whether or not you are working with a financial advisor who has a fiduciary obligation to keep your best interests in mind when selecting your investments.
Whether you are counting on a computer or a person to manage your money, you should seek to work with a financial advisor who has a fiduciary obligation with your account (Rule #3).
Problems with Revenue Sharing with Robo-Advisors and with Financial Advisors
The revenue-sharing practices described in the article create problems for you if you happen to be one a wealth management client at Morgan Stanley or Merrill Lynch.
First, revenue-sharing adds to the cost of the funds that you own, because you pay the cost of sponsored conferences, gifts, and entertainment in the form of higher fund fees. On average, the cost of these funds and ETFs is going to be more expensive than the cost of owning funds and ETFs that do not have to make such payments.
More importantly, revenue-sharing means that you are likely going to own suboptimal investments. For example, Vanguard Group, which offers a wide selection of excellent, low-cost mutual funds, is not available for purchase on platforms like Morgan Stanley or Merrill Lynch because they refuse to “pay-to-play.” The choices are limited to those funds that make appropriate payments rather than those funds which might be the best investment for you.
John Strauss (no relation) has some appropriately harsh words to say about these conflicts of interest.
John Strauss, chairman of FallLine Securities LLC and a former wealth management executive at UBS Group, JPMorgan Chase, and Morgan Stanley. ‘When I’m a client of one of those firms, I think I’m seeing the best ideas,’ says Strauss, whose business helps advisers go independent from big brokerages. ‘Really, what you’re seeing are the ideas they have arbitrarily decided they can make enough money on to show you.’
Given his work history, Mr. Strauss should know better than most how the game works. These financial advisors do not have a fiduciary duty to their clients. Because they are not acting as fiduciaries, they are allowed to place clients into products which are not in their best financial interest. If you are a participant on one of these robo-advisor programs, it’s a good idea to assume that you will own investments that are not the ideal choice for you.
Mr. Strauss’s former employer, Morgan Stanley, revealed in its disclosures that some companies provided it with as much as $550,000 per year for “sponsoring seminars or paying the meal, travel, and hotel expenses of brokers attending sales events.” In addition, some companies provide as much as $500,000 per year for data about mutual funds and as much as $550,000 for ETF data.
I would make two points here. First, I interpret these payments as amounts provided to Morgan Stanley per company. Across all of the fund companies that seek to be available on the Morgan Stanley platform, this must add up to many millions of dollars each year. Second, it’s not just Morgan Stanley; all of the large brokers have similar disclosures involving their material conflicts of interest.
Does your financial advisor have a fiduciary obligation with your account? If not, why do you choose to work with them?