If you’re sliding into DMs, don’t do it on WhatsApp.

Conversations with clients over non-monitored platforms, like messaging apps or personal emails, have become public enemy No. 1 for the Securities and Exchange Commission. The agency has already dished out more than $3 billion in fines regarding off-channel communications, with another 11 firms from Invesco to Stifel getting dinged this week. More than two dozen advisors agreed to sanctions last month: Ameriprise, Edward Jones, LPL, and RayJay paid $50 million each. 

It’s a considerable crackdown that’s now coming under fire from members of the agency itself. Commissioner Hester Peirce told lawmakers the initiative has turned into a “cash cow” for the SEC. “The typical case has not been based on fraud,” she said during a House Financial Services hearing Tuesday.

Channel Surfing

While it seems simple to stay off unapproved apps, the issue is actually a little more nuanced. According to lawmakers at the hearing, much of the off-channel comms occurred during the onset of the pandemic, when advisors were working from home and had little choice but to reach out to clients on personal phones. (We would all like to forget pandemic-era Wi-Fi issues.)

“COVID changed the world and the way we do things,” Peirce said. “That’s why we should have taken a regulatory approach first.”

Hold The Phone. On the other hand, the agency is just doing its job. When all is said and done, the actions may deter bad apples from providing misleading information to investors. “We’ve seen far too many examples of stock brokers and advisors attempting to defraud investors by misrepresenting what they’re selling them,” said Bill Singer, a securities lawyer with over four decades in the industry, adding that “surreptitious” conversations, more likely than not, occur on private lines.

The agency has also appeared to be indiscriminate in its actions, targeting both large financial institutions and smaller independent shops:

• Citigroup, Goldman Sachs, Bank of America and 13 other firms were collectively fined more than $1 billion in 2022 for using WhatsApp and personal emails.
• New York-based Senvest Management became the first RIA fined for off-channel comms in April of this year.

Message In a Bottle. The agency will also need to be careful that enforcement actions aren’t punishing new forms of communication or making it harder for advisors to reach out to clients. Millennials and Gen Xers, for example, are much more comfortable than previous generations with online communication.

The SEC also has to make sure it’s spending its precious time and resources on the most important challenges facing the industry. “You have to wonder if the just-published settlements are more calculated as a diversion rather than an example,” Singer said. “Did they truly merit being placed on the SEC’s front burner?”

It’s not just McDonald’s that’s offering value deals. 

Investors are looking for budget-forward products, too, shifting their focus from higher-cost actively managed vehicles to lower-fee passive funds. Approximately $180 billion was pulled from active equities in the first half of 2024, while passive equities saw inflows of $279 billion over the same period, according to a McKinsey & Company report. 

It’s upending traditional revenue streams for asset managers.

Back from the Brink

2022 was rough for the markets, but the financial industry is in recovery. Global asset managers hit a record AUM of $132 trillion as of June 2024 — that’s up 8% from last year and a 21% rise from 2022. Despite the impressive growth, revenues remain stagnant, creating “leaky boats” in a rising tide for managers, according to McKinsey. The report found:

• From the beginning of 2023, significant outflows from open-ended active equity funds led to a revenue loss of $2.5 billion for the industry.
• Fees for new products are also plummeting, averaging 20% lower than existing ones.
• Managers are seeing growing demand for cheap ETFs, as issuers have already begun converting existing mutual funds into passive products.

Sinking Feeling. Interestingly, on the fixed-income front, both active and passive products performed well, attracting $333 billion and $142 billion, respectively, with expectations that these trends will continue through the end of the year.

“Today’s asset management industry operates as a two-speed market,” the McKinsey report said. “It’s in equal parts a place of intense competition with challenged product segments and a market that’s ripe with promise.”

Mutual funds may be the king of asset classes, but ETFs, especially the active variety, are gaining plenty of favor with advisors. 

Nearly 30% of wealth managers had exposure to active ETFs, according to a Fidelity report that reviewed more than 3,000 professionally managed portfolios in the second quarter. That’s up from just 13% in 2022. Active funds are gaining traction because they have all the benefits of regular ETFs — tax efficiencies, lower costs than mutual funds, liquidity, and transparency — but can actively try to outperform the market. They’re also benefiting from advances in trading platforms, model portfolios, and lower transaction costs, according to the report.

“The rise in ETF allocation has been quite staggering,” Fidelity SVP and head of investment specialists Michael Scarsciotti told The Daily Upside. He added that advisors allocated 42% of their portfolios to ETFs in total in the second quarter, about half of which were active products. 

New Kid on the Block

Not only are more advisors adding ETFs and their active variants to portfolios, but the allocation is increasing as well. Overall ETF allocation stood at 27% in 2023, 21% in 2022, and 18% in 2021, Scarsciotti said. As for active ETFs, the average allocation was around 17%, according to the report. 

While active ETFs debuted during the Great Recession, they hit prime time after a Securities and Exchange Commission ruling in 2019 made it easier to launch them. Additionally, Scarsciotti said advisors are adding extra shareholder value through active management:

• Active ETFs gathered roughly 30% of the US asset management industry’s inflows this year as of August, according to a VettaFi report. However, they still represent less than 10% of US assets.
• Globally, there are about 13,200 active ETFs on the market, and they’ve accounted for 70% of product development since 2019. Active ETFs are soon expected to represent $1 trillion in assets under management.