In his August column for Investment Advisor entitled “What Will Become of Us?” Pershing Advisor Solutions CEO Mark Tibergien posed several questions regarding the future of investment and financial advice and potential challenges (from Amazon, from custodians, and from the Securities and Exchange Commission and Financial Industry Regulatory Authority) that might emerge. He went on to offer a few predictions.
Mark is correct to point out that evolution will continue in the financial and investment advice space, and perhaps even accelerate. The pace of change will vary over time, and it will be affected by new competitors and regulatory developments.
The following are my own predictions of the future changes that will likely occur in the financial and investment advice profession — and how these shifts will impact registered investment advisors, in particular.
Between the dangers posed by the SEC’s Reg Best Interest to broker-dealer business models, as well as the substantial increase in consumer’s knowledge of, and demand for, fiduciary advice, the investment advisor profession will continue its strong growth in the years ahead.
1. Large RIA firms will become larger.
Especially as founders of existing, smaller RIA firms continue to age and seek exit strategies. Some larger RIA firms will merge. Other large RIAs will be bought out by private equity investors. A few will go public.
But new small RIAs will be formed, due to the ongoing entrepreneurial spirit of many investment advisors, paired with their quick ability to adapt to new technologies, and the continued development and emergence of high-quality software platforms for smaller RIAs.
2. Margins for RIA firms will be reduced.
No surprise here. After reasonable officer compensation is paid, expect margins to fall to 10%, from their current level of about 20%, for wealth management firms.
3. Small RIA firms will eschew outsourcing portfolio management, but will begin to rely upon independent consultants for investment strategy due diligence and for mutual fund/ETF/other pooled investment vehicle selection.
Paying an outside investment manager basis points to manage a portfolio will diminish over time, when just mutual funds and ETFs are utilized in portfolios.
Instead, smaller RIAs will begin to embrace independent firms that provide research (for a flat fee each year) into investment strategies, portfolio design, and investment product selection.
Independent and objective academic research and back-testing of investment strategies, with forward-thinking analysis applying predictions of the macro-economic environment and incorporating testing for the impact of severely negative macroeconomic events, will result in the expert portfolio strategy/product due diligence that many RIA firms need today. The smaller RIAs will then implement those strategies themselves, aided by ever-better portfolio management software.
4. RIAs will pay a fixed annual fee for access to custodial platforms, plus per-account fees.
This is inevitable as other sources of custodian income (revenue sharing payments from funds, payment for order flow and revenue from cash held in low-interest accounts) are discontinued due to new legislation, regulation or enhanced fiduciary due diligence.
5. Fiduciary standards will emerge from the SEC and DOL, in a strongly applied manner, under a new administration.
The foundations for this push are already present, including:
A.) A keen knowledge among policymakers of the importance of the fiduciary standard;
B.) The substantial coalition of dozens of consumer and other groups that support the fiduciary standard;
C.) Greater knowledge of just what “fiduciary” means and what a bona fide fiduciary standard requires (especially when a conflict of interest is present);
D.) A desire to walk back the current SEC’s strongly criticized “Regulation Best Interest” (the title of which is deceptive);
E.) The desire to occupy the fiduciary space at the federal level, as continued competition emerges from more states moving to impose their own fiduciary standards; and
F.) Greater endorsement of, and less opposition to, the fiduciary standard as more and more Certified Financial Planners exist, bound by their voluntary acceptance of a stricter fiduciary standard than the SEC currently requires.
The “incidental advice” exemption for brokers from the application of the Advisers Act also will be substantially narrowed. All this is a question of “when,” not “if.” And, once instituted for a couple of years, this new era of “fiduciary investment advice” will be very difficult to unwind.
6. This will drive more firms and advisors toward fees paid by the client rather than fees derived from products.
A.) There will be a realization that it is nearly impossible to properly manage a conflict of interest, in order to keep the clients’ best interests paramount to the interests of the financial advisor. It is better to avoid conflicts of interest where possible.
B.) Fees will reflect the level of service and expertise applied, and will be “reasonable.”
C.) While levelized commission platforms will emerge, questions will arise concerning whether even a reduced 3% or so commission is “reasonable compensation” under a fiduciary standard, when so little advice is provided.
D.) All ongoing (even intermittent but often) investment advice eventually will become subject to the fiduciary standard; only quite limited “sales exceptions” and “education exemptions” will exist.
7. Asset managers’ fees will continue to decline.
A.) The annual expense ratio of mutual funds and ETFs will decline.
B.) 12b-1 fees will disappear — if not by regulatory fiat, then by pressure arising from an ever-increasing number of fiduciary advisors who understand that 12b-1 fees add no value to a mutual fund’s shareholders.
C.) Other revenue sharing payments will cease.
D.) Soft dollar payments by funds to brokerage firms will either disappear by federal legislation, or will diminish under pressure from fiduciary due diligence.
E.) Greater focus will emerge on the internal transaction and opportunity costs within funds and ETFs.
F.) ETFs will gain greater market share, in part due to lower transaction costs (as they affect continued fund shareholders), and in part due to the tax-efficiency of equity ETFs. (However, Congress may seek again to change the tax rules in this area.)
G.) Sharing of securities lending revenue with the investment advisor or its affiliates will be banned.
H.) As alternative sources of revenue dry up for fund companies, the annual expense ratio (AER) for mutual funds and ETFs stabilize, but at lower average AER levels than are present today.
8. “Flat annual fees” — whether paid in quarterly installments or via monthly subscription services — will become more prevalent.
Asset-based fees will continue, but will decline. Forward-thinking RIAs will bifurcate fees, charging robo-advisor like low AUM fees for investment portfolio management, while charging flat annual fees for ongoing financial planning.
9. Technology will continue to lower portfolio-management fees.
The “robo-advisors” who are not yet profitable (as many still are not) will disappear or merge (or they will be acquired by a profitable hybrid-model firm). Advisors know “robo-advisor” services are just a great integration of technology, with a slick web interface.
Technology integrations will continue to get better. While larger RIA firms have deeper pockets to review and implement technology solutions, smaller RIA firms will continue to see software emerge for their use at substantially less cost.
10. Mutual funds and ETFs will continue to see increased use for a period of time, but then portfolios of individual securities will become dominant.
This latter trend will be aided by block trading and more sophisticated portfolio management software. Tax and cost efficiencies will continue to fuel this evolution, not only for very large accounts, but increasingly for smaller and smaller accounts.
Smaller RIAs may initially pay to outsource this form of portfolio management, but when they reach the size to have a dedicated trading desk staffed by three or more individuals they will consider taking this form of portfolio management in-house.
11. Under the expert scrutiny of fiduciaries, sales of higher-cost variable annuities and fixed-index annuities will decline.
Insurance companies increasingly will realize that the tail risk assumed in various riders to VAs and FIAs is not justified by the premiums received (net of commissions paid).
Fiduciary advisors will continue to use nonqualified VAs where tax deferral is warranted, but policies will be stripped of most riders and no-load, low mortality and low annual expense fee policies will rise to the forefront.
Sales of FIAs will decline as more low-cost alternatives that use similar strategies emerge (such as the SWAN ETF), and as fiduciary advisors increasingly understand the uncertain risks posed by insurance companies that possess unexceptional financial strength, or the liquidity risks present for many (even highly-rated) insurance companies should another financial crisis occur.
Doubts concerning the continuation of unfunded state guarantee funds should another Great Depression arise also will be a factor in fiduciary decision-making.
12. The title “financial planner” will require licensure in an increasing number of states.
Those who don’t meet certain minimum educational and testing requirements, such as those found in the CFP certification (and/or some equivalent education and testing of foundational knowledge), will not be able to utilize this term.
13. “Financial planning” will become regulated as an add-on to state regulation of individual investment advisors.
Peer-review structures will be put into place in many of the states to assist in evaluating complaints against individual financial planners or firms. While efforts to have “financial planning” established as a regulated profession at the federal level will occur, absent another major financial crisis such efforts will not likely succeed.
14. Over time, consumer trust in personal financial advisors and the demand for personal financial advice will explode.
Once greater educational standards exist for entry into the profession and higher standards of conduct are in place (and conflicts of interest are minimized), more and more consumers (many of whom eschew personal financial advisors for now, for they “don’t know who to trust”) will seek out personal financial advice.
For many clients, “financial life” checkups will become as routine as regular physician check-ups.
15. Personal financial advisors will become “life coaches.”
Financial planners, most of whom already embrace a large breadth and depth of knowledge that can be applied to client situations, will continue to embrace “financial life coaching.” Personal financial advisors will continue to apply insights into what drives most clients’ ultimate goals:
A.) To lead a life that results in greater happiness for both clients and persons near and dear to them; and/or
B.) To leave a positive impact upon the community or world-at-large via leading a meaningful life.
16. Defined contribution plans will continue to dominate, but broader application of ERISA’s fiduciary standards will occur.
ERISA’s fiduciary protections are extended to governmental 403(b) and other similar non-ERISA plans. Via legislation in Congress, safe harbor protections are created to absolve plan sponsors from potential liability — provided fiduciary investment advisors are engaged.
17. One defined contribution plan will rule them all.
The U.S. government consolidates the many various types of defined contribution plans into “one defined contribution plan for all,” with a standard-form utilized for plan adoption and with a simplified menu of options.
All employers are required to offer qualified retirement plans and/or payroll deduction to IRA accounts. Contribution limits are made more uniform.
Defined benefit plans continue to exist for many government entities and some firms, but with lower maximum contribution limits; the number of new employees enrolled in defined benefit plans continues to decline, overall, in the United States.
18. In the long term, routine examinations and inspections of RIA firms will become far less frequent and intrusive.
Once conflicts of interest are minimized throughout a greater portion of the investment advisory profession, a cost-benefit analysis of frequent inspections reveals their lack of true impact as a means of consumer protection.
Inspections involving firms that possess custody, however, become more frequent and more robust, as a means of deterring Ponzi schemes and other frauds. More frequent targeted inspections serve to prevent frauds often start small from becoming much larger.
It’s also worth pointing out these four threats to the profession:
1. State-run retirement plans
Continued opposition to the application of fiduciary standards, coupled with the messaging from broker-dealer firms that small accounts cannot be serviced unless high commissions and other fees can be charged, will continue to fuel the growth of state-run, low-cost retirement plans — to the chagrin of all in financial services who believe that such is not a proper function of government.
2. A FINRA takeover of RIA regulation
FINRA, whose market share and revenues continue to decline, will seek to take over the regulation of RIAs (although the states, along with the CFP Board and other organizations, will strongly push back against such a takeover).
If FINRA succeeds, the movement toward further embracing bona fide fiduciary standards stalls, and even reverses. Rising regulatory costs from becoming subject to FINRA would drive many smaller RIA firms to merge, and the cost of entry into the investment advisory space would dissuade many new RIA firms from forming.
3. Tax-policy changes
Substantial changes in tax policy may emerge that eliminate tax-deferred and tax-free investment vehicles and products, including any further contributions to defined contribution plans and IRAs. The elimination of Roth IRAs, in particular, will be seen as an avenue to raise revenue.
Other tax law changes may force the annual recognition of capital gains and losses, as well as have them taxed as ordinary income. Still other changes may further eliminate itemized deductions, including all state/local taxes and mortgage interest.
“Universal health care” will eventually occur (via a combination of non-profits and Medicare), and this will result in the elimination of deductions for amounts contributed to Health Savings Accounts.
“Tax simplification” may reduce the value proposition of some financial advisors, and lead to substantially easier-to-file tax returns (with “draft returns” prepared for many wage earners by the IRS itself).
4. Monied interests and politics
Powerful economic interests oppose many reforms, and slow down others. Without a Constitutional amendment to overturn Citizens United, efforts to modify the regulation of financial and investment advice will be slowed.
But, even then, reform efforts will continue at the federal and state levels, aided by broad recognition of the need to continue to reform the standards for the delivery of financial and investment advice, with reforms occurring during the favorable regulatory climates that exist from time to time at both the federal and state levels.
Ron A. Rhoades, JD, CFP, serves as the director of the Personal Financial Planning Program and assistant professor of finance in the Gordon Ford College of Business at Western Kentucky University. He also is an investment advisor and an estate planning/tax attorney, and he has often served as a consultant to broker-dealer, RIA and compliance firms. This article represents his own views.