DOL Rule Adds to Mutual Fund Industry Headwinds

Moody’s Investors Service has downgraded its outlook for asset management firms from stable to negative, citing in part the added pressure on mutual fund fees expected after the Labor Department’s fiduciary rule is implemented.

Between 2007 and 2015, the rotation of assets into passively managed mutual funds and exchange-traded funds vastly outstripped flows into actively managed mutual funds, which yield fund companies higher fee revenue.

Over that period, $1.5 trillion flowed into ETFs, and $700 billion flowed into passively managed mutual funds. Just over $400 billion flowed into actively managed mutual funds during the nine-year period ending in 2015, according to Moody’s.

The ratings agency expects that trend to continue, saying in its 2017 outlook report that performance of active management “continues to underwhelm” and that investors will remain cost-conscious in a low-return environment.

The fiduciary rule, which requires investment advisors to act in the best interest of investors in IRAs and 401(k) plans, will accelerate flows into cheaper passively managed investments, according to Moody’s outlook. Moody’s and other analysts expect the fiduciary rule will encourage an industry-wide transition to fee-based advisory services, which in turn will incentivize the recommendation of lower-cost investments.

Investors can also expect to benefit from increased competition among passive fund managers, which will continue to drive down the cost of passive investments.

Moreover, the size of passive funds — the average passive fund is triple that of the average actively managed fund, says Moody’s — will also create management cost efficiencies that puts downward pressure on fees.

(Related: Chamber’s CEO: ‘Already Working’ With Trump to Kill DOL Rule)

Neal Epstein, a vice president and senior credit officer at Moody’s, says the fiduciary rule will flip the balance of power in the investment management industry as advisors adopt a fee-based model of compensation.