When the Charles Schwab & Co. selected the 54 funds that would go into its robo-adviser, it extended an olive branch to its rival, the Vanguard Group Inc.
Schwab is using a dozen Vanguard products in the robo-advice platform, Intelligent Portfolios, almost as many as the 14 of its own exchange-traded funds. That's a strong embrace by Schwab of its largest rival in the world of low-cost, index-tracking ETFs.
But Vanguard will not be returning the gesture. In its own direct-to-consumer digital advice platform, dubbed Personal Advisor Services, scheduled to debut by this summer, Vanguard is using only its own products.
The different tacks offer a window into the tough choice facing large investment firms embracing the increasingly digital role of building portfolios for investors: to include or not include the competition?
“The optics of it are a little challenging for me,” said Matt Lynch, managing partner at Strategy & Resources, a consulting firm in Dayton, Ohio. “From a marketing standpoint, if I am an adviser and I have a client asking me about Vanguard's personal advice platform, that's a pretty easy response saying they're only putting you in their funds.”
BEST FOR CLIENTS
For their part, the firms say their approaches are best for their clients.
“For us it made sense just to offer our funds,” said Katie Henderson, a spokeswoman for Vanguard. She said the firm's delivery of products “at cost” and its funds' favorable performance compared with benchmarks were among the reasons its funds work best. “We do believe that since we are leading with an index portfolio at the core that our funds are the best suited for Personal Advisor clients.”
A Schwab spokesman said the firm's process for selecting funds did not consider who managed the products.
“The focus in selecting the funds is on achieving diversification and cost efficiency for investors, and we established an objective set of criteria to accomplish that without regard for whether the funds were ours or from a third party,” said Michael Cianfrocca, the spokesman. “Low [operating expense ratios] was a primary factor in those criteria and that led to ours and third-party funds.”
These and other digital platforms are growing in significance, and human advisers are seeking ways to either compete with or use the platforms to develop their own businesses. Vanguard has not yet said if it plans to roll out an institutional version of its platform.
Both firms offer advice to retail investors. Schwab, though, taps into the larger adviser force through its own branch network as well as its custody unit for independent advisers, the largest in the U.S. (Intelligent Portfolios, which launched this month for consumers, is scheduled to be rolled out in an institutional version for those adviser clients later this year.)
Both Vanguard and Schwab build market-tracking index funds and ETFs, though Vanguard reigns supreme in that business. At Schwab, those funds account for $78.5 billion; at Vanguard, it's $2 trillion.
And both companies offer those products at the industry's lowest prices. Schwab's index ETFs, for instance, charge annual expenses averaging 16 basis points; Vanguard's are 13 basis points, according to Morningstar Inc. That compares to an industry average of 58 basis points. (One hundred basis points equals 1%.)
But the differences in the firm's approach may come down to the different nature of their businesses.
Because Schwab offers fewer and somewhat more expensive proprietary funds, it's harder for the firm to justify limiting itself to its own products, according to Ron A. Rhoades, assistant professor of
financial planning at Alfred State College in Alfred, N.Y.
LOWER CONFLICT OF INTEREST
“Vanguard's lack of an incentive to generate profits for shareholders results in a substantial reduction of the conflict of interest present,” Mr. Rhoades wrote in an email. “Given the fact that Schwab is a for-profit company, how Schwab manages its conflicts of interest is certain to receive a greater deal of scrutiny as time goes on.”
Vanguard's program includes a component with human financial advisers.
Unlike Vanguard's program, Schwab's retail offering charges no management fees on top of the funds. Instead the firm generates revenue in part through reinvesting cash allocations in the fund and receiving payments from some of the third-party fund managers and brokers it uses. Vanguard typically does not pay those kinds of distribution fees.
Mr. Cianfrocca said Schwab relies on
disclosed criteria. “We mitigate any potential conflict by adhering to written objective criteria in selecting funds,” he said. “Ultimately, this is about providing a service aimed to help investors reach their goals.”
