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Riding the waves of zero-fee disruption

The elimination of commissions on online trading will make it easier for advisers to use direct indexing and tax-loss harvesting

Nov 12, 2019 @ 11:52 am

By Eric Clarke

When we discuss the ways disruption has affected the technology we use and the work we do, the impact is often framed in a linear fashion. One thing changes, and then something else adapts immediately in reaction to that change.

While this is true for the planned and intended results of disruption, I find the unintended consequences behave more like a splash, rippling outward. And as splashes go, the final leap to zero-fee trading by leading brokerages hit like a bowling ball dropped into a bathtub.

We saw the immediate effects of Schwab's decision right away: a dive in stock prices as shareholders projected how much revenue would be lost from vanishing ticket charges, the rush by competing brokerages to follow suit, the surge in trades from investors emboldened by the end of trading fees.

But I believe our industry will feel the ripples from these moves for years to come. Here are some areas where I think we'll see the biggest changes:

A crack in Vanguard's armor?

Almost immediately, we realized zero-fee trading widens the use case for direct indexing.

Where advisers might once have incurred $400 to $600 in fees every time they rebalanced a custom-tailored basket of securities, those costs have disappeared. And one of the last, lingering arguments against direct indexing — the cost of owning full shares of the hundreds of individual stocks needed to replicate an index — has just been eliminated by Schwab, which has opened the door for investors to purchase fractions of stocks. It's hard to imagine other major brokerages will not follow suit.

Put together, this means an adviser can assemble a cost-effective alternative to ETFs, bypassing the funds's, swapping out underperformers and nixing whichever stocks a client might object to on principle, and bring this service to a much larger market.

Over the next few years, we'll see direct indexing proliferate to the point where it may disrupt Vanguard's ETF-led industry dominance.

[More: Zero-fee trading was a warning shot. Asset management is next]

Unearthing hidden opportunities

Direct indexing is not the only strategy to gain a lift from the zero-fee movement. I think a growing number of advisers will realize they're sitting on a potential goldmine already within their books of business.

One of the biggest stumbling blocks for advisers who want to employ tax-loss harvesting has been expensive transaction costs and the lack of connectivity between SMA optimizers and rebalancing solutions when it comes to actually executing the trades.

With zero-fee trading, we'll see more advisers evaluate more clients for tax-loss harvesting strategies. To give you an idea of what's at stake, at Orion we checked for tax-loss harvesting opportunities and found billions in unrealized losses! If your broker has instituted zero-fee trading, it's nearing year-end and is absolutely time to generate tax alpha for your clients.

[More: What zero commissions mean for B-Ds]

The stampede to independence

This is a golden age for breakaway advisers. Anyone who wants to strike out on their own already benefits from a wealth of technology, outsourced services and support networks to ease their transition, the likes of which we could not have imagined 20 or even 10 years ago.

Zero-fee trading can only sweeten the deal, as advisers will have access to trading platforms where their clients won't pay ticket charges. This, combined with Schwab's swift move to fractional investing, opens the door to investment strategies that, until now, might have been unthinkable or cost-prohibitive. All of these factors combined appear to have created the field of dreams scenario for existing firms to recruit breakaways.

What this boils down to is a leveling of the playing field that favors independent advisers who can swiftly capitalize on industry changes. There has never been a better time to embrace the freedom to pick your own tech, build the teams you want and serve your choice of clients — and it's a lot easier for nimble independents to seize the competitive edge that comes from disruptions like these.

[More: Find your Fosbury Flop: Innovating on the fundamentals]

Eric Clarke is the founder and CEO of Orion.

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