Whether or not this fiduciary rule from the Department of Labor—or any fiduciary rule—is ever actually implemented, one thing is certain: 401k plan advisors are (or should be) adjusting the way they do business, including the products and services they offer. Or more importantly, the products and services they don’t offer. Here’s what we mean.
Since the final rule was announced in early 2016, report after report has attempted to ‘crystal ball’ its impact on future business. Advisor surveys conducted ad nauseam mostly produced results like Market Strategies International’s Cogent Reports, which finds “overall negative industry gloom” and advisors who believe “that the DOL action is…limiting their product selection.”
Fine, but what about those with a more optimistic, glass-half-full outlook?
With the rule initiates a higher standard of care, experts are generally bullish on the products that will benefit most, but caution 401k advisors on the services that could take a hit, as well as any “hot, new ideas” that may emerge.
Fiduciary Friendly Mutual Funds
A shift to more fiduciary-friendly products is already occurring, says Jeff Atwell, senior vice president of retirement services at Meeder Investment Management.
The usual suspects, including Vanguard, Dimensional Fund Advisors, American Funds, T. Rowe Price and Fidelity are all moving to offer more institutional versions of their retail funds.
“I think you will see specifically-engineered 401k funds and, over time, every major fund company will have institutional share classes, especially if they want to stay relevant,” adds Jason Grantz, director of institutional retirement consulting at Unified Trust.
Grantz sees more prevalence in no-load/no-revenue mutual funds in the 401k space. He points specifically to the lowest-cost versions of mutual funds that include index and passively managed products.
Conversely, any mutual fund with a higher-than-peer average expense ratio will face market challenges, and fee transparency will of course drive product choice, especially as litigation concerns mount.
“Platforms that are revenue-neutral and transparent, in terms of record-keeper fees, will be looked upon more favorably,” Atwell observes, noting that service providers who disclose all compensation and fees, both direct and indirect, will have a marketplace advantage.
Atwell adds that it’s similar to what he experienced as a 401k advisor and third-party administrator in the early 1980s, before widespread revenue-sharing adoption.
“We are definitely going back in time, in terms of compensation structure, because of the fiduciary rule. The new future is total transparency.”
Exchange-Traded Funds
High-profile speaker and author Michael Kitces, a partner and director of research with Pinnacle Advisory Group in Columbia, Maryland points to exchange-traded funds as a product that’s closest to what fiduciary rules already require, and therefore will be the easiest for near-term adoption by new fiduciary advisors.
“ETFs operate in a space that doesn’t have product commissions, so they are not running afoul of fiduciary elements,” he says, but adds that they will see an increase in price competition. “In a fiduciary rule world, you cut your prices to the lowest cost and that’s who wins,” adding that mutual funds and ETFs will become even more commoditized.
“You are either the lowest cost indexed fund or you are dead.”
Target date Funds
Atwell believes target date funds will further evolve in regard to glide path construction. As technology improves, advisors and plan sponsors will have the increased ability to create more customized TDFs to meet their specific plan’s goals and objectives, which will appeal specifically to fiduciary-minded advisors and plan sponsors.
He notes the sharp increase in TDF assets since 2008, and that many TDF glide paths have been constructed to create alpha instead of managing volatility. As a result, if the markets become more volatile, participants who have placed their retirement assets in a target date fund could be disappointed. Plan fiduciaries should document how the TDFs that are utilized in the plan were selected, and how they will monitored on an ongoing basis.
Annuities
Advisors see a tough road ahead for annuities (as does the National Association for Fixed Annuities), while others think fiduciary issues will create more opportunities in the space.
For example, Morningstar recently forecast major changes for insurance companies because of what the fiduciary rule didn’t do. The insurance industry had hoped fixed and variable annuities would revert back to Prohibited Transaction Exemption 84-24, but both remained under the best interest contract exemption, according to Morningstar analyst Michael Wong.
“I think that threw a wrench into many insurance companies’ ideas of how to actually respond to the rule,” Wong wrote.
Kitces calls the annuity industry “one of the biggest losers” under the initial phases of the fiduciary rule because of its reliance on commissions.
Atwell agrees, and already sees it happening, pointing to Boston-based Cerulli Associates’ research that predicts a continued decline for variable annuity sales at an annualized rate of close to 10 percent as the DOL rule is implemented through 2017 and 2018.
Yes, the commission-based nature of annuity products creates potential conflict-of-interest headaches under the new regulations, but Kitces sees a potential upside if commissions are squeezed out.
“If you strip commissions out of annuities, it becomes a better product for consumers and easier for the advisor to meet fiduciary obligations,” he says. “It could be a new form of lower cost or fee-based annuities specifically built for fiduciaries. And more money can be put in the consumer bucket instead of the commission bucket.”
Additionally, Grantz has seen some “definite politicking” occurring to create safe harbor provisions for annuity-like income-generating products.
As a result, “I’m not convinced that annuities are a goner for 401k advisors.”
Money Market Funds
Because of the SEC’s recent updates to the regulations that govern money market mutual funds, Atwell says they too will require a higher level of fiduciary oversight, which may make them less enticing after the fiduciary rule is implemented. There are other alternatives to the money market option, he notes, such as a stable value fund or guaranteed investment contract.
“With these products, advisors need to closely document their investment files and ensure the recommendations are appropriate or they will have a breach of duty.”
Despite whatever aforementioned negativity felt by the 401k advisor industry over an increase in fiduciary oversight (official or not), long overdue changes that positively impact the space are almost certainly a result.
“Advisors will see commissions and costs getting squeezed, which I think will lead to companies making better products,” says Kitces. “The breadth of low cost choices for clients is about to get a whole lot better.”
He adds that all eyes will be on “whoever will put a solid stake in the ground and win the price war” and that “distribution is now the main game in town.” Companies like iShares, BlackRock and Vanguard are especially well-positioned in the ETF space, but don’t be surprised by a dark horse to come from nowhere.
“Many companies didn’t care about this segment before, but now they do. Fidelity wasn’t a fan of ETFs and didn’t even have them on their radar. But now, they’re saying they’re here to stay.”
The fiduciary rule also creates opportunities for advisors to make the case to keep money within the 401(k) plan, which in turn, places the burden on other advisors to prove it’s in a client’s best interest to roll it out and into an IRA.
Atwell, who once again emphasizes a likely return to a style of business seen in the 1980s, is optimistic.
“This may help us evolve back to a professional service-driven industry versus a commodity-driven one,” he concludes. “In the end, it will be good for consumers, participants, and eventually, it will be good for advisors.”
Lynn Brackpool Giles is former Managing Director of Communications and Consumer Services for the Financial Planning Association (FPA). In this senior management role, she oversaw all corporate and strategic communications, media relations, legislative communications and consumer affairs for the national association.