Imagine getting paid to invest! I recently came across an article on Bloomberg titled – “Fate worse than zero finally arrives in fund land.” SEC USA has approved an ETF with negative fees. New York-based Salt Financial has launched an ETF where they will pay investors 50 cents for every $1000 invested. This is fee compression and market expansion at a different level. Some call it a marketing gimmick and other industry watchers opine it is the trend of moving towards lower and lower costs for the investors.
When we started www.indiainfoline.com (incidentally the website was launched on May 11, 1999) Nirmal and I were convinced that the Internet will change everything, and business models would get disrupted. Old models will die, and new ones will emerge. We ourselves shut our paid research model and put everything on the Internet for free.
I perused the article to understand where Salt Financial’s catch was? The income stream can be stock lending fees. It says when the fund size crosses $100mn, fees structure will go to $2.90 for every US$1000 invested. Apparently, at that size of assets, one can get listed on platforms. The fund manager will have a dilemma when the fund size reaches $90mn. Should he increase fees and lose the early set of investors who helped him, in the hope that advisors will get him investors who will pay $2.90? From negative fees to $2.90 is a big delta for a direct customer and he may just redeem and move his assets elsewhere. Will negative or zero fees be the new normal?
Fund fees in ETF world are heading down sharply, so the entrepreneur has crossed the zero barriers and made it negative. If other Internet companies can burn cash in the name of customer acquisition, then why not in funds management business? Instead of paying distributors and advisors, he is spending the marketing and sales budget on end customers directly. The market for ETFs is lopsided – like a true Internet economy – 3 companies, i.e. Vanguard, BlackRock and State Street, control over 80% of US assets. Also, Gen X is investing in ETFs in a big way. They seem to be convinced that active fund managers do not deserve extra fees for alpha generation.
As I write, analysts at Moody’s Investors Service have termed Salt Financial’s move as “credit negative for asset managers because it furthers the relentless march towards fee compression in the fund industry.”
I am convinced that passive funds will do well in India. We launched the least cost ETF some years ago but had to restructure as increasing the AUM to respectable levels was a challenge. Maybe the timing was wrong. Or maybe we did not persist long enough given other objectives of our firm. In today’s tech-friendly ecosystem, low-cost ETFs make sense. With technology, eKYC, direct code, and various enabling factors, passive funds are gathering assets, but the tipping point appears far away.
What stand will the regulator take in case an entrepreneur launches an ETF with negative fees in India? Will this step be seen as investor friendly or will be viewed look using the inducement/ mis-selling lens? This is an interesting conundrum. On one hand, if the regulator wants costs to come down, should negative costs be encouraged? On the other hand, if the investor loses money, will the inducement angle then kick in?
In an Indian context, although the direct code has done well, passive funds are still lagging. Investors are still chasing alpha or at least investing in hope. Data on this subject is mixed depending on the angle of study. The answer is clear – reduce costs.
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