Brokers who sell index funds may get a leg up from newly proposed requirements that would impose more stringent standards for professionals who provide advice on retirement accounts.
The Department of Labor
proposal would require brokers to act in their clients' best interest and disclose any conflicts when offering guidance for retirement investment accounts — a new fiduciary standard.
Buried in
the voluminous, 444-page proposal, sent out for public comment this week, is a caveat that could make it easier for broker-dealers to meet their requirements under the law if they sell low-cost index funds.
“Facilitating investments in such high-quality, low-fee products would be consistent with the prevailing (though by no means universal) view in the academic literature that posits that the optimal investment strategy is often to buy and hold a diversified portfolio of assets calibrated to track the overall performance of financial markets,”
according to the proposal.
The agency offers, as an example of a high-quality investment for long-term investors, a low-cost, index-tracking target-date fund “consistent with the investor's future risk appetite trajectory.”
For a shorter time period of five to 10 years, the Labor Department said a “risk-matched balanced fund or combination of funds” was an example of a recommendation also “likely to be sound” from that “prevailing” point of view.
"We plan for this low fee streamlined exemption to move forward with the rest of the proposal, and, if it can be worked out, adopted as part of the final exemptions," the agency said in an emailed statement. "An important part of this whole process is getting constructive public feedback and this includes how best to operationalize this exemption. We have been talking with various stakeholders on this and other issues and look forward to receiving formal comments when the proposal opens for public comment" on April 20.
NARROW RANGE OF PRODUCTS
The proposal raised the possibility that standards regulators apply to investment advice could steer investors to a far narrower range of products and providers. In the case of index-tracking target-date funds, just 11 U.S. fund companies offer such products and one company, the Vanguard Group Inc., controls 81% of the $252 billion market, according to Morningstar Inc.
“After adjusting for fees and cost differentials, it is not clear that passively managed funds outperform actively managed funds,” said Ron A. Rhoades, a professor and prominent advocate of fiduciary standards. He said the funds often incur market costs when they are forced to trade as the index's components change.
“Fiduciary due diligence requires much more than a simple comparison of annual expense ratios,” he said.
A spokesman for the Investment Company Institute, a trade group for the $17 trillion industry that includes mutual funds, pointed to
a statement the organization made Wednesday that “investors must be able to have the choices they need to make sound investment decisions."
“That includes the choice between active and passive,” the spokesman, Mike McNamee, said Friday.
Vanguard officials are still reviewing the proposal.
“We look forward to working with the DOL to ensure that its proposal both protects investors and enables them to have continued access to much needed advice,” said Vanguard spokesman David Hoffman.
MORE-STRINGENT STANDARD
The more-stringent standard for brokers sought by the proposal is at the heart of a regulation that seeks to limit conflicts of interest for retirement advice. The White House Council of Economic Advisers
has said conflicted retirement-savings advice costs investors up to $17 billion annually. President Barack Obama has personally voiced support for the DOL proposal.
Unlike the standard that exists today, firms would be allowed set their own compensation models for these fiduciaries. Brokers could be paid for their services in a variety of ways, including through commissions, revenue sharing and so-called “12b-1” fees paid by the companies that sell investment products.
In order to be allowed to be paid that way, the broker or their firm would have to demonstrate they are acting as fiduciaries. Among other things, they would have to adopt policies to prevent harm from conflicts of interest and receive “reasonable” compensation.
But the so-called “low-fee streamlined exemption” would allow brokerage firms to sidestep some of those requirements “without satisfying some or all of the conditions.”
It's unclear whether the examples of balanced funds and index-tracking target-date funds reflect the federal government's views about the superiority of passive investing or were just examples. A spokesman for the agency, Michael Trupo, did not respond to a request for comment.
