New analysis from Morningstar suggests even aggressive estimates of the Department of Labor’s proposed fiduciary rule’s effect on the financial services industry are being low-balled.
About $3 trillion of client assets and $19 billion of revenue at full-service wealth management firms will be impacted, according to Morningstar analysts.
There will be some winners, according to the rating agency’s analysts.
Over $1 trillion could flow into passively managed mutual funds and exchange-traded funds, if the rule were finalized as proposed.
Advisors compensated by third-party revenue payments, which would be prohibited under the proposal’s best interest contract exemptions, would be swayed to recommend more passive investments, the report says.
And up to $600 billion of low-value IRA accounts can be expected to be let go by full-service wealth management firms.
A portion would likely find a home in passively managed investments offered by robo-advisors, which stand to benefit from the rule.
Discount brokerages will also step in with passive options to accommodate those accounts exiled from wealth management firms.
Of the 25.8 million IRA counts examined by the Employee Benefits Research Institute, about 45 percent held less than $25,000 in 2013.
Industry analysts have suggested smaller accounts won’t be worth the cost of compliance to wealth management firms under the DOL’s proposed rule.
That probability has buttressed both opponents and advocates of the proposal.
Opponents say the cost of complying with the rule will leave a gap in access to advice for low and middle-income savers, while advocates, such as Labor Secretary Thomas Perez, say robo-advisors can readily fill that void to the benefit of investors.
Passive investments also stand to benefit from what likely is an unintended consequence of the proposal.
Commission-based compensation, which the rule does not prohibit, can be charged, so long as such commission-based sales are fully disclosed in the proposal’s best interest contract exemption.
The cost of doing so will encourage advisors to charge a management fee, in lieu of commission-based products. That could provide revenue yields of $13 billion annually, according to Morningstar.
That of course flies in the face of the DOL’s original purpose — to address investor losses to conflicts of interests on commission-based investments.
As clients pay more in fees than they previously did in commissions, advisors may be incentivized to move money into cheaper passive investments, to offset the increases in the cost of advice Morningstar says the rule will create for some investors.
To date, Morningstar’s report says analysts have been focused on implementation costs when assessing the rule’s affect on industry.
On the high end, those costs have been estimated at $1.1 billion annually, the report claims.
But when considering revenue, which previous cost estimates fail to do, industry stands to lose $2.4 billion in annual sales, on the low end of Morningstar’s estimates, to the rule’s prohibited transaction rule.
Morningstar estimates IRA assets to be in excess of $10 trillion by 2020, as more baby boomers retire and roll assets from employer-sponsored plans into individual accounts.
In 2012, more than $300 million was rolled over from employer-sponsored plans, far more than the $50 million IRAs gained in contributions that year.