What Are Adviser Class ETF’s?

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Date posted: 09.18.2011 (11:21 pm) | Write a Comment  (0 Comments)

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An increasing trend in ETF’s and especially for covered call ETF’s is to launch “adviser class ETF’s”. What is an adviser class ETF? Let’s go back just a second. One of the only reasons why mutual funds still have so much assets is because when advisers buy them on behalf of their clients, part of the very expensive fees that is charged in the fund is paid back to the adviser. How does this work? Easy. Let’s imagine that an adviser buys for $100,000 worth of a fund. If that fund charges 2% of annual interest, the adviser could have an agreement in place where he gets part of that. In the case where he agreed on 0.50%, that would mean $500 being paid to him every year as long as the fund is held.

What Is The Impact?

I’d say there are benefits and downsides. One major advantage is that this type of product reduces the need for advisers to trade often (incurring costs, commissions, etc) as they can focus on finding quality funds instead that will be good over the long term. That being said, it also costs a lot more than other types of investments such as ETF’s. Also, it gives mixed incentives to the adviser. He would probably prefer going for a fund that will give him a bigger commission as that will have a huge impaact over time.

Enter Adviser Class ETF’s

One of the aspects of ETF’s that slows down the growth is the fact that advisers have few incentives to have their clients buying and holding them. The commission on one such trade is usually less than $50 and the ETF can be held for several months, years and sometimes even decades. That creates a major problem for advisers. On the one hand, they should buy the best products for their clients but if they do, their commissions will be impacted severely.

What certain ETF providers have found is that they could create adviser class ETF’s that behave in a similar way. They are traded on exchanges but do still pay a commission to the adviser.

How Do Adviser Class ETF’s Manage To Pay The Commission?

No, they do not make less money. Instead, these funds charge a bit more in fees to the holders to help pay out those trailer fees.

Who Should Buy/Hold Adviser Class ETF’s?

There is no reason for someone trading its own account to buy such a fund. However, if you do have an investment adviser, it might be fine for him to buy you such products. I would however expect the adviser to disclose the fact that he is getting paid for it, that a better product exists but he will only get paid by buying the adviser class. I think that can be defended.


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