Apparently, this town is big enough for the two of us.

After Charles Schwab announced plans to expand its retail-facing Schwab Wealth Advisory business to new markets, a move that could position it to compete with some of its 16,000 RIA custody clients, executives are trying to calm any fears those independent advisors might have. “There’s $37 trillion in the marketplace; more than enough for everyone to have success,” Jon Beatty, head of advisor services, said during a press briefing last week. “We rarely bump into each other.”

While advisors tend to feel confident that clients won’t leave them for a major firm, there’s still a fair bit of, let’s say, tension. “Advisors have to use custodians, and when they provide wealth management services themselves, how do we know they’re not going to try to poach clients?” asked Bryan Byrer, founder of Millennial Financial Planning, who custodies with Schwab and is happy with the service overall.

My, How You’ve Grown

Schwab plans to expand its reach from 20 affluent markets to 30 by the end of the year. The firm maintains that it wants to serve clients any way it can. While that means growing its own wealth business, it also means supporting RIAs beyond custody. “Custody is table stakes,” Jalina Kerr, Schwab managing director of advisor services, said at the press briefing. She added that the RIAs Schwab works with are asking for help with alternative investments, lending services and business consulting.

Landon Tan, founder of Query Capital, said Schwab might not be a direct competitor to the RIAs it serves, but it can sure feel like it. He pointed to Schwab’s “Carl” ads, which he argued portrays independent advisors as expensive and ineffective. “It would be embarrassing to hold Schwab out as your custodian and then have clients see that your ‘partner’ openly mocks you,” Tan told Advisor Upside. Still, advisors who deliver value have little to fear. “If your clients are getting great value working with independent advisors, they’re not going to switch to a giant retail firm.”

Schwab’s RIA custody business remains a major growth engine:

• Schwab custodies $5.5 trillion in assets for RIAs that partner with the firm, Beatty said.
• Those RIAs brought in $86 billion of net new assets from 88,000 households in the first quarter.

“Our pulse on the market is that advisors are growing and thriving in their businesses with us,” Beatty said.

Not Too Worried. Not all advisors see Schwab’s move as a threat. “I’ve had plenty of clients move their assets from a Schwab-employed advisor to me,” said Chris Diodato, founder of WELLth Financial Planning. He added that Schwab lacks personalized expertise and often feels more sales-oriented. “It’s the same complaint I hear when people are working with wirehouses or retail banks.”

Fixed income not doing much for you? You can buff that out.

Active ETFs are often marketed as vehicles to beat the market and generate outsized gains. Historically, though, most active strategies have struggled to outperform passive investing over long periods. Goldman Sachs argues advisors may be thinking about the category the wrong way. Instead of replacing core equity exposure, some active ETFs, particularly buffer funds, may work better as substitutes for part of a portfolio’s fixed-income allocation.

Clients generally hold bonds and cash not because they maximize returns, but for ballast. Recessions, layoffs, medical bills, college tuition and home purchases all create a need for stability and liquidity. Proponents say buffer ETFs offer some of that protection, while still keeping investors tied to equity-market upside.

“Defined outcome strategies are a tool for advisors to take clients’ low-risk assets, and instead of tying them to fixed income, where returns are going to be more limited, they can tie them back to the upside in the equity market,” Tim Urbanowicz, chief investment strategist at Innovator ETFs, said at a Goldman event last week.

Young and Old

Rather than a traditional 60/40 portfolio, allocations could evolve toward something closer to 60/20/20, with part of the bond sleeve replaced by defined-outcome strategies. Urbanowicz pointed to expectations that funds tracking the Bloomberg US Aggregate Bond Index could return roughly 4.5% annually over the next decade. Buffer ETFs, by contrast, could provide better returns while still offering some downside protection.

The products are popular among investors nearing or in retirement who want to preserve assets while still participating in market growth. But advisors are also increasingly using them with first-time investors wary of market volatility and ultra-high-net-worth clients sitting heavily in cash, Urbanowicz said. “So many clients out there have a mental hurdle of, ‘I can’t get into the equity market because I have the potential to lose money,’” Urbanowicz said. “The reality is, since COVID, if you didn’t have your money invested, you just lost 25% of the value.”

Issuers First Trust and Innovator, which Goldman finished acquiring this year, have essentially cornered the market:

• At the end of last year, defined-outcome funds from First Trust and Innovator held roughly $40 billion and $28 billion in assets, respectively, according to Morningstar.
• There is the issue of fees, though. A passive bond strategy could have an expense ratio as low as three basis points. Meanwhile, the average fee across Innovator’s buffer ETF is 80.

Breaking Bonds. Morningstar Analyst Zach Evans stressed replacing fixed-income with buffer strategies doesn’t eliminate equity risk. “They could be used as a ballast in a portfolio, however, you’re still highly correlated to the equity market,” he told Advisor Upside. He added that while buffer ETFs are technically active, they tend to act more like passive funds, often following a rules-based strategy instead of on-going securities selections. “From a business perspective, that might mean lower overhead than discretionary management,” he said.

Put your money where your … beliefs are?

Gen Z and millennials seem to be on board, viewing faith-based investments as more appealing than older generations do, according to a recent Crossmark survey. Many younger investors are even seeking advisors who can help prioritize values in the portfolio-building process, with a significant portion likely to choose an advisor that offers values-based investing over one that doesn’t. Advisors with younger clients said this trend is visible in their practices, and they’re finding ways to accommodate them without meaningfully sacrificing performance. Those who ignore this trend, or outright dismiss values-based investing, risk alienating an important client segment, said Crossmark CEO Bob Doll.

“These generations are creating and inheriting significant wealth,” Doll, former chief equity strategist at Nuveen and BlackRock, told Advisor Upside. “They care about things like corporate governance, sustainability, workplace safety and, increasingly, policies that support the family, like paid parental leave. They don’t have to sacrifice performance to get it.”

Advisors’ Experience

Dana Menard, advisor at Twin Cities Wealth Strategies, says younger clients are “definitely more conscious” about aligning investments with their values. It used to be logistically challenging to do so, he said, but technology improvements and work by asset managers has changed the game.

“Younger investors want portfolios that reflect who they are,” agreed Jeffrey Judge, advisor at Chesapeake Financial Planners. “It’s not a fringe preference anymore. I had a couple in their late 30s last year who came to me specifically because they’d left an advisor who brushed off this conversation.” By the numbers:

• 44% of millennials and Gen Z said values-based investing is important, more than double the rate (19%) of retired respondents.
• Three in four respondents under age 41 would choose an advisor that offers values-based investing over one that doesn’t.

The performance question is where nuance comes in, advisors agreed. “Doll is right that you don’t have to sacrifice returns to invest this way, but that’s true on average and over time,” Judge said. Generally, performance parity depends heavily on which values screen one is applying and over what time horizon. A broad ESG screen over a diversified global portfolio is one thing. Uber-strict screening of stocks according to religious principles is another.

Stacking Up. Matthew Higbie, advisor at Birchwood Capital, recently analyzed biblically responsible investing funds. The data shows it’s hard to beat market cap-weighted index funds over time, but he expects many Christians would switch to BRI funds if performance remains relatively close. He found one leading BRI fund has actually outperformed its total stock index benchmark, but most have lagged by between 100 and 400 basis points.

Allan Moskowitz, advisor at Transformative Wealth Management, has likewise found values-based investments performance can be competitive, noting the sustainability-focused MSCI DSI Index has outperformed the S&P 500 index for over 30 years on average, although there are shorter-term periods in which it hasn’t.