Schwab: Automated Solutions Aim to Help Clients Streamline

Jeff Ptak: From the 30th Annual Morningstar Investment Conference in Chicago, I'm Jeff Ptak, global director of manager research at Morningstar. I'm very pleased to be joined today by Walt Bettinger, he's president and CEO of the Charles Schwab corporation.

Walt, welcome to the Morningstar Investment Conference. It's a pleasure to have you.

Walt Bettinger: Well, thanks, Jeff. Thank you and congratulations on 30 years.

Ptak: Thank you so much. I wanted to start with one of our key conference themes, which is enabling technologies and automating decision-making. It's an area in which Schwab has been an innovator and has built up quite a bit of expertise and over $30 billion, if I'm not mistaken, in your Schwab intelligent portfolio and related solutions. So I'm curious, looking back on the past three or so years since you developed it, some of the important lessons that you've learned about optimal use case, who's the most eligible client for that type of solution?

Bettinger: The genesis of intelligent portfolios was research that we did with existing self-directed clients of Schwab. What we did is we sat down and showed them data about their financial results compared to other individuals who are getting professional investment advisory services. In general, they under performed. So we said, "What would it take for you to consider professional advice to get better outcomes?" They said, "Well, I want a lot of diversification, I want automatic rebalancing, tax loss harvesting. I want the fees to be very low in terms of ETFs, and oh by the way, I'm not going to pay for it, with an explicit advisory fee."

What we did is we took that information, went out and built intelligent portfolios, and of course, those clients have adopted it in fairly rapid fashion. I think even today, it's still targeted toward people who otherwise might be self-directed investors.

Ptak: When you go through your progressions and you're trying to make sure, sort of validate it, is it working as we intend it to do, I mean what has that yielded? Are there insights that have led you to make some adjustments to it or do you feel like it's working as you'd originally envisioned?

Bettinger: It's working pretty much as we thought. We've made some minor tweaks in the asset allocation, but it's not designed to be a tactical asset allocation program. But we made minor tweaks. What we generally look at is making sure that within the different programs that the actual historic performance and then projected performance into different environments would line up and make sense with the risk profile of the various portfolios that we construct. So very minor tweaks. In general it's worked quite well. In fact, I think maybe the only credible third party that evaluates talks about our outstanding performance. That's not the objective of it, but we have had fairly strong relative performance.

Ptak: I want to also talk about sort of the role that an automated solution like that plays in your broader corporate strategy and maybe how that's evolved. Is the place where you're at in thinking about Schwab intelligent portfolios in your strategy different than maybe where you were at the outset, the role it can play, how it sort of figures in and how you solve problems for clients.

Bettinger: I think again it's, as you said, really all about the client. If this type of solution makes sense for clients, then that's what we're going to go ahead and build. That's what we're going to go ahead and offer. And for us, any issues that go along with that, whether it be revenue cannibalization or other implications, don't really matter. Of course, that's sort of the history of Schwab, is that we're going to do what makes sense for the client without really worrying that much about near-term revenue implications because that's how you build a franchise over time.

Ptak: In a related vein, I'm curious. When you're having conversations with advisors who are thinking about ways to streamline their practices or make them more efficient, really using enabling technologies as an adjunct to what they do, what's the counsel that you're offering to them? Are there certain types of activities that you're saying, "OK, in three to five years, you should make it your goal to fully automate those."

Bettinger: Absolutely. Yeah, absolutely. If I think about the custodial model for independent investment advisors, it's still almost in version 1.0. It's not that different than what we started 25, 30 years ago. Custody, trading, reporting, reconcile. But when you think about solutions like the institutional version of intelligent portfolios, or many of the things that we're introducing today for RIAs, it's enabling them to move to almost a 2.0 version of what the custodian can do for them. I think advisors who are taking advantage of that are more efficient, they're more at scale, and frankly, they're delivering a better client experience.

Ptak: What do you think happens to fees? I'm sure it's a question that you get a lot, but advisor fees in some respects, sort of the final frontier, given some of the economizing that's been happening in the marketplace. Do you think that we'll see fee pressure and that will result in advisors being in increasingly competitive situations where they have to lower fees to basically win business?

Bettinger: It's hard for me to believe that the investment advisory space is any different than anywhere else in our economy, which means that in all probability, there will be a degree of downward pressure on fees, but there will also be pressure to deliver greater services. Now the wonderful thing for advisors is firms like Morningstar, Schwab, and others in the investment advisor space ar delivering technology capabilities that can enable the RIA to do just that for their clients: Deliver a better value while still delivering a better experience and of course, in that case, everyone wins.

Ptak: I wanted to talk about sort of related to behavior, obviously behavior modification an important function that an advisor can play in a good relationship with a client. It's a key theme here at our conference. You have a unique vantage basically overseeing servicing trillions of dollars in assets. I know business volumes have been up recently, strongly so, and so I'm curious, are you seeing any worrisome signs of behavior when you look across your client base? Are they engaged in what you would consider to be generally constructive activities that help them to reach their goals?

Bettinger: I think their activities are generally constructive. We've seen we're a little bit below our historic average in client's cash weightings, but not a lot. Maybe a percent or a percent and a half below historic norms. But in general, clients both served by the advisors we work with as well as retail clients are sticking to a long term plan. A diversified plan. It's nothing like the world we saw in say, the late '90s.

Ptak: I wanted to talk about one other theme of our conference and that's sustainability. Thinking beyond the quotient of return to risk as perhaps we've traditionally done, focusing on things like sustainability. I know for you as overseers again, of trillions of dollars of assets, you know, you have to engage with companies. One of the issues that's come up recently is we've had Warren Buffett, Jamie Dimon, penned an op-ed in which they basically implored corporate America to get away from short-term earnings guidance. What's Schwab's position on that? Do you think that that's constructive and that's an issue that companies should take up?

Bettinger: Well, we have great respect for Mr. Buffett and Mr. Dimon. But we were here years ago. We have never given guidance on our quarterly results. We just don't believe that that's a constructive approach for long-term investors, and the people who most would value that are not the people who are looking to be investors in Schwab stock, so we completely agree. We've never done it and we have no plans to go into a world where we would offer quarterly guidance.

Ptak: Before we conclude, I want to shift gears a bit and talk about investment management, and sort of the definition of winning. I think that sort of how it is, firms would define winning has evolved quite a bit in recent years, especially with the flight to low cost. I'm curious, for Schwab, how has the definition of winning in investment management, how has that evolved for you as a firm, and do you expect that in 10 years' time, there'll be an altogether different definition that you're working towards?

Bettinger: I think what we view in investment management, in our very narrow proprietary side, Charles Schwab investment management, is we want to offer low cost core building blocks for portfolios. There's a lot of exceptional managers, both active and passive, who do a wonderful job on slices of the portfolio outside the core building blocks.

Our objective is not to try to replicate the results or the capabilities that they have. We hone in low cost, ruthless low cost core building blocks for portfolios. I would expect that strategy to be consistent for us for a long, long time.

Ptak: Do you think, going back to behavior for a second here, obviously it's laudable that investors seem to be seeking out the lowest cost solutions in many cases. Do you see any signs that it's being overdone a bit and perhaps the pendulum has overswung in their zeal to minimize costs from portfolios?

Bettinger: Well, I'm going to steal something a little bit from Morningstar's own research, which I think is to say that the greatest predictor of quality performance in asset management often is fees, and maybe one of the only factors that you can utilize with few exceptions to predict future performance. I don't know that I'd go so far as to say that people have over-rotated. I think the consciousness of the importance of keeping costs low, though, is a wonderful thing for investors. Ultimately, it's leaving more money in their pocket where it belongs, giving them a better chance of reaching their goals.

Ptak: Walt, great insights. Thank you so much for participating in this year's Morningstar Investment Conference. It's our great pleasure to have you here.

Bettinger: It's an honor to be here. Thank you for the invitation.

Ptak: From the Morningstar Investment Conference, I'm Jeff Ptak.