Views on improving the integrity of global capital markets
07 June 2016

Morningstar Report Determines Winners and Losers of DOL Fiduciary Duty Rule

Washington, DC, is known—and regularly scorned—for its role in picking winners and losers through its legislation and regulation, a stigma that dates back centuries. So, it should come as no surprise that the Department of Labor’s (DOL’s) fiduciary duty rule, one of the most sweeping regulatory changes of recent decades, is widely expected to help some existing players while hurting others. Although the rules don’t involve direct infusions of money into the winners, it is expected, nevertheless, to produce changes in the way significant sums of investor money are invested.

Morningstar, a Chicago-based rating agency, has thoroughly assessed the new rules and determined that it will produce three primary trends.

  • First, it will shift customers from commission-based arrangements to fee-based structures, which is estimated to increase industry revenue by $13 billion.
  • Second, robo-advisers will likely pick up a large percentage of the $600 billion in low-net-worth IRA balances currently held by full-service wealth managers.
  • Third, it could lead to a significant increase in the use of passive investment products.

In aggregate, Morningstar predicted that $3 trillion in retail client assets are at stake, relating to $2.4 billion in fee revenue. That is more than double the $1.1 billion in compliance costs the industry estimates will be needed.

The Winners and Losers

On the basis of these trends, the rating firm concluded the rule will favor those engaged in discount brokerage as well as those selling exchange-traded products and index funds. By contrast, life insurers and alternative asset managers are seen as the likely losers. Their high commissions and vertical integration are the areas Morningstar believes will create the problems for insurers.

“[W]e believe that companies that rely heavily on annuity sales and investment services will feel the greatest impact,” Morningstar reported in its Financial Services Observer prior to release of the DOL’s rules. The rules “will make it very difficult for many investment agents and professionals to continue offering investment services and retirement products to clients.”

Morningstar highlighted two reasons why it will be difficult. First, the new rules will look at insurance agents advising about the sale of annuities as fiduciaries, and thus needing not only to enter best interest contracts with their clients, but also to justify high-cost investment instruments to skeptical regulators. Even worse, they will have to justify those instruments to skeptical trial attorneys.

Rise of Robo-Advisers and Passive Investing

The new rules are expected to have mixed effects on full-service wealth managers, although the overall effects will tend toward the negative. For example, Morningstar said the sector will encounter negative effects from the shift toward fee-based accounts, which, while producing higher revenues per account, will cause as much as $600 billion of low-net-worth IRA assets to find new investment channels. Among the beneficiaries will be firms offering advice through robo-advisory systems.

The shift toward robo-advisers is seen pushing such firms toward the critical threshold of $16 billion to $40 billion in collective assets under management, which is believed as the level they need to attain profitability. The use of robo-advisers, meanwhile, is seen directing investors toward passive investment products. Discount brokers, too, are seen furthering the trend toward passive investing because of the DOL rules.

It has been apparent since the introduction of the DOL’s rules in April 2015 that it would cause some firms to lose. The Morningstar report helps describe who the losers are as well as indicate who will be among the winners.

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About the Author(s)
Jim Allen, CFA

Jim Allen, CFA, is head of Americas capital markets policy at CFA Institute. The capital markets group develops and promotes capital markets positions, policies, and standards.

2 thoughts on “Morningstar Report Determines Winners and Losers of DOL Fiduciary Duty Rule”

  1. Stephen Campisi, CFA says:

    The DOL has a myopic view that focuses on fees to the exclusion of almost all else. While it is true that many clients do not understand the nature of a true fiduciary relationship, the best answer to this is to require appropriate disclosure and explanation by financial intermediaries. There is a legitimate role for those who simply provide advice rather than making decisions on behalf of their clients. The DOL is not helping address the critical problems that will continue even after the dust settles on their legislative efforts.

    One such problem that still remains is when so-called fiduciaries do not act in the best interests of their clients by investing and measuring success in terms of the clients’ goals, and measuring risk in terms of failing to meet those goals. Instead, we continue to see risk measures that only evaluate the fund managers’ risk of being fired. As a result, we continue to see risk evaluated solely in terms of a manager’s ability to beat a benchmark or peer group. What has that got to do with the likelihood of mission failure in meeting the clients’ funding goals?

    This was most evident in the pension industry, where plan sponsor “fiduciaries” continued to remain heavily invested in equity following the run up in the decade preceding the market downturn of 2000 – 2002. Many of these pension plans had surpluses between 30% and 50% which was enough to,defease the next 30 years of liabilities while investing the remainder in equities. This would have reversed the typical allocation from 70/30 in favor of equities to a conservative 30/70 stock/bond mix. Following the payment of those liabilities and withstanding the market downturn, the defeased plans would have still been in surplus, while the typical plan moved to a deficit condition.

    The first requirement of a fiduciary is loyalty, expressed as understanding a client’s goals and risk tolerance and investing appropriately, measuring success in terms of meeting the client’s monetary goals. Why did these plan sponsors continue to expose the beneficiaries to high levels of unnecessary equity risk when they had enough capital to eliminate all risk in paying the next generation of liabilities? This was not a matter of market timing but rather aligning asset allocation to the client’s risk and return goals. Because these managers did not act like fiduciaries, they missed the opportunity of a lifetime, and turned significant surpluses into deficits.

    How would the DOL ruling have helped this problem? Frankly, it would have ignored the problem. Why? Because all the DOL sees is the fee paid for financial services. It should be looking at the quality of the services, and more importantly demanding that fiduciaries act like fiduciaries where it really counts – in investing according to their clients’ “true risk tolerance” stated in terms of meeting monetary financial goals.

  2. P.Teague says:

    How will this address corporate fraud & recovery? That is the Question.
    It appears the comment above by Stephen Campisi CFA outlines it will simply not.

    NYSSA Event Unwraps DOL (Fiduciary) Rule via @MarketIntegrity

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