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DOL Fiduciary Rule: Who Wins, Who Loses

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Around $3 trillion of advised, commission-based brokerage IRA assets will be subject to the Department of Labor’s new fiduciary rule, reshaping the financial industry, Morningstar has concluded.

At the Morningstar Investment Conference in Chicago, panelists outlined a recent Morningstar report that shows the positive and negative monetary impacts the DOL fiduciary rule will have on the industry.

One of the panelists was Michael Wong, a senior equity analyst at Morninstar and the lead author of the report, “Final Department of Labor Fiduciary Rule’s Effects Are Substantial.”

“Through its ability to influence the policies and procedures of wealth management firms and the behavior of financial advisors to many tax-qualified accountholders, the entire value chain from financial product manufacturers to financial product distributors and investors has to be reconceived,” the report states.

According to Wong and the Morningstar report, here are the four biggest winners and three biggest losers under the DOL fiduciary rule:


Passive Investments

Morningstar predicts there will be a shift to relatively lower-cost passive investment products from actively managed and says passive investments could gain more than $1 trillion of assets from the fiduciary rule.

“There are definitely some types of funds we think will be advantaged: passive investing products, relatively lower cost, any kind of asset management firms that cater to 401(k) retirement platforms as there might be less rollovers,” Wong said during the Morningstar panel. “If you’re in any of those spaces, you’ll probably do pretty well.”

Morningstar believes that passive investment share will accelerate thanks to “the reduction in potential conflicts of interest stemming from third-party payments, increased adoption of robo-advisors, and total-cost balancing,” according to its report.


Of passively managed products, Morningstar predicts that primarily index funds and exchange-traded products like ETFs will be the biggest beneficiaries of the rule.

According to Morningstar, changing financial product allocations among broker-dealer reps could lead to a large increase in ETF assets as BDs move to a fiduciary standard.

Digging down into just the shift of assets into ETFs, Morningstar estimates “a reasonable opportunity upwards of $140 billion based on the ETF product allocation difference between RIAs that are currently under a fiduciary standard and broker-dealer advisors under a suitability standard,” according to its report.

‘Conservative’ Investments

According to Wong, funds that have relatively low drawdown or are relatively more conservative or less volatile will also have an advantage under the DOL fiduciary rule.

“Because … the enforcement mechanisms for this fiduciary rule [are] possible arbitration or litigation,” he said. “When is this likely to occur? This is likely to occur if the client loses money. So how do you prevent that? You might want to put them in something – from a practical standpoint and if it’s in the best interest of the client – into something that is relatively more conservative or lower drawdown.”


From 2014 to 2015, the client assets at several of the leading robo-advisors increased over 150%, according to Morningstar. And Morningstar predicts that growth will continue thanks to the fiduciary rule.

“We continue to believe that the stand-alone robo-advisors, like Wealthfront, are a logical landing place for clients with low account balances who may be unprofitable for full-service wealth management firms,” the report says.

Morningstar predicts that if these stand-alone robos captured just a fraction of the $250 billion to $600 billion of low-account-balance assets they would accelerate their growth by several years and bring them closer to a break-even point with wealth management assets.

While the fiduciary rule will be a needed boost to the robo-advisors that serve investors directly, Morningstar predicts it will be “an even greater accelerant” to robo-advisors or digital advice technology used by the established full-service wealth management firms.

Morningstar predicts that digital advice companies that support wealth management firms will experience “a more explosive growth rate than that experienced by the robo-advisors serving investors directly, as they can quickly leverage the advisor networks they tap.”

As evidence, Morningstar point to BlackRock’s FutureAdvisor unit, which has already signed agreements with LPL Financial and Royal Bank of Canada since the beginning of 2016.


IRA Rollovers

According to Morningstar, more than $200 billion of annual IRA rollovers are covered by the rule, which could reduce inflows to wealth management firms and benefit retirement plan platform providers.

The DOL fiduciary rule classifies advice on rollovers from an employer-sponsored plan to an IRA as fiduciary advice. This means even level-fee RIAs have to comply with the streamlined best-interest contract that requires acknowledging fiduciary status and documenting why the rollover is in the best interest of the client.

According to the Investment Company Institute, 63% of households with traditional IRAs used a professional financial advisor as a source of information when making their rollover decision. Translating this into dollar terms, Morningstar estimates that more than $200 billion of annual rollover assets will be covered by the fiduciary rule.

Wong called this “one of the most important numbers that we quantified.”

“If those advisors are not able to substantiate why a rollover is in the best interest, this cuts off one of the primary sources of inflows into the practice and would severely stagnate the growth of client assets (in wealth management),” Wong said during a media briefing.

Under the rule, wealth management firms will have to substantiate why a rollover will be in an investor’s best interest or risk reductions in asset inflows. The documentation must take into account the difference in fees and services between the employer-sponsored plan and the IRA. Because of the increased compliance procedures and potential difficulty in justifying a rollover, it’s reasonable to believe that more assets will stay in employer-sponsored plans like 401(k)s.

Assets staying in 401(k) plans will benefit retirement plan platform providers, while reducing net inflows into wealth management firms.

Looking at rollovers from the perspective of financial advisors that may decline to advise small-balance clients, Morningstar estimates that nearly $50 billion of IRA rollovers are for amounts less than $100,000 and that about $10 billion of IRA rollovers annually is from households that don’t possess $100,000 of total investable assets.

Alternative Asset Managers

“Alternative asset managers and life insurance companies will be challenged,” Wong said during the MICUS panel. “Definitely the Department of Labor fiduciary rule puts fixed income annuities and variable annuities under best interest contract exemption.”

Many alternative products, such as nontraded real estate investment trusts and derivatives, come with relatively high fees. According to Morningstar, the bar for justifying these alt products in a retirement account under a best-interest obligation is then much higher than more standard products such as mutual funds and exchange-traded REITs.

“We believe that some of these higher-expense products are likely to be challenged. They really have to adapt,” Wong told the crowd at the conference. “They could lower their expenses so that makes the ratio a bit better … or they have to further substantiate why it works in a client’s portfolio.”

The DOL has stated that it would pay particular attention to the recommendation of these products, that advisors should document why their use is in the best interest of the client, and that continued monitoring of the investment past the initial recommendation may be needed to satisfy the best-interest obligation.

“Maybe it’s not the best product in isolation,” Wong said. “That said, if you were to look at it in context of the overall client’s portfolio – look at in comparison to the cash allocation, equity allocation – what kind of additional factors or benefits does this alternative product provide to the client? We see that as one way that financial advisors will be able to demonstrate or substantiate there is a reason why they’re recommending this alternative asset or this annuity product to their client.”

Life Insurance Companies

A major adaptation that Morningstar expects in the life insurance industry is more annuities that work well with fee-based accounts. According to Morningstar data, only about 4% of variable annuity sales are structured as fee-based instead of commissionbased.

“We also believe that there will be a greater emphasis placed on benefit riders with variable annuities to validate their compensation payments, as the Department of Labor has expressed skepticism regarding the tax benefits of certain products when used within tax-qualified accounts,” the report says.

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