This week marks two anniversaries of significance for me. Thirty years ago this week, the first exchange-traded fund (ETF) had its initial public offering (IPO). I bought shares in my own account on the IPO of the Standard and Poors Depository Receipt (SPDR), which tracks the S&P500. I knew it was a game changer. 

This week’s second significant anniversary is somewhat related – the inception of the Segment ETF Strategy in January 2003. That first account, owned by a physician client, is still intact today at multiples of its original value. 

The invention of the ETF was met with resistance from Wall Street. It was an anti-Wall-Street product, and they knew it. My employer at the time, UBS, pitched a fit when I proposed merging my discretionary practice with ETFs. They eventually relented, and I was one of a handful of advisors in the country allowed to manage client assets for a fee on a fully discretionary basis, meaning I chose securities I wanted without prior client approval. In the brokerage model, client contact is how the brokerages avoid fiduciary duty. It is how they saddle the client with responsibility for anything that goes wrong. It is also how brokerage firms avoid liability for conflicts of interest because clients are given the opportunity to ask questions beforehand. Never mind that they don’t know what to ask. 

Client Conflicts

Conflicts plague the brokerage model. These range from double-dipping client fees to backroom deals where client trading info is sold to third parties to side deals with mutual funds using client purchase activity as leverage to drive institutional activity to the brokerage’s trading desk. The biggest threat ETFs posed to UBS was the elimination of 12b-1 fees; the firm made tons of money from these fees from mutual funds. 12b-1 fees are kickbacks where mutual funds embed extra costs in their fee structure and return that money to the brokerage firm that holds the fund for clients. ETFs were a huge threat to the gravy train since they didn’t contain 12b-1 fees at the time. Today, just a handful of the more than 2000 ETFs have any 12b-1 fees, and even those that do are tiny compared to traditional mutual funds.

UBS eventually appointed me to the task force to pilot test ETFs on their platform. Only six of us in the country were allowed to do this among 7000 UBS advisors. It was such a success that I did what UBS feared I would do. I mowed down all of my money managers, liquidated virtually all of my client mutual fund holdings, and converted them to ETFs and individual securities with even better tax control. These moves saved my clients more than $300,000 in fees annually at the time. With fees having dropped since and Segment now being six times the size of my UBS practice, today I estimate that my clients save more than $1.7 million annually in fees they would otherwise be paying UBS and others for zero added benefit.

Client Benefits

Clients don’t always recognize these benefits, but they trust that I recognize them and will act on their behalf accordingly. While ETFs only comprise 20% of Segment’s client assets, their investor-centric philosophy impelled me to arrange my client assets in a way that benefitted them and me as well. While I didn’t start Segment until 2010, my vision for the firm took shape in 2003 when I made my move to ETFs.

In 2018, I wrote a letter to Jack Bogle, thanking him for inventing the index fund in 1976. I cherish his kind, handwritten response just months prior to his death in early 2019. Next time you stop by the office, look for it hanging on the wall in my conference room. 

Thanks for bearing with me on this nostalgic musing, but this week marks an important anniversary for us all. 

To read more about ETFs, check out this previous musing: Why Are ETFs Better Than Mutual Funds?

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