Debashis Chowdhury
President
Canterbury Consulting
Newport Beach
We view the fiduciary rule as a positive for investors large and small. Many advisers were already working this way with clients, and this cements and codifies the good things the industry was doing. It’s a confirmation of what we have always thought was the right way to interact with clients: putting their best interests first. Canterbury’s independence has always allowed us to be objective—and provide conflict-free advice—when doing manager research and making investment recommendations to our clients.
The rule will really impact smaller investment accounts. Therefore, the investment advisory industry needs to determine how best to provide the services to those accounts. Robo advisers can supplement and provide quality service to a group of investors who would otherwise be without counsel. We view that as a positive because more people will have access to investment services.
However, we believe robo advisers will never replace human connection, interaction and custom-tailored investment solutions with each client’s specific objectives and constraints in mind—the very foundation of sound financial advice. For nonprofit endowments, foundations, wealthy families and family offices, for example, objectives and strategies are increasingly too complex and specific for the robo adviser service model.
Robo advisers tend to work best for passively managed funds, a recent trend we’ve seen increasing. We differ in that we believe there’s a place for both active and passively managed funds in many client portfolios.
Each client is unique, with different goals and objectives. So, too, is their use of active or passive strategies. Some fee-sensitive clients use passive investing to decrease their investment costs. Others use passive investing only in the most efficient asset class, such as U.S. large-cap equities. Those trying to optimize after-tax wealth use a passively managed strategy to harvest losses. Some use a full suite of active managers to leverage the skills and expertise of professional investors.
We help our clients identify their objectives and create a portfolio using active, passive, or a combination of both that puts them in the best position to achieve their specific goals.
Another thought on the passive trend is to take a cautionary tone. For example, we have seen a lot of retail money be moved due to underperformance with active managers. But it is critical to view results over a full market cycle and not fall prey to short-term market volatility or short-term trends.
Elias Dau
Market Executive
Merrill Lynch Global Wealth Management
Newport Beach
Many observers view the new fiduciary rule as the most significant regulatory change within the wealth management industry in more than four decades.
Bank of America embraced the rule’s core principles and since 2010 has advocated for a consistent, higher standard of care for all professionals advising the American people on their investments. When considering the impact of the rule to our Merrill Lynch Wealth Management clients, the primary goal was to make a set of decisions rooted in our clients’ best interests.
Since 1974, the government has identified retirement plan assets as special, and we completely agree with that. We have determined that for most of our Merrill Lynch clients, the best way for us to deliver retirement-related investment advice that meets the fiduciary standard is through our Investment Advisory Program. In addition, we are seeing clients increasingly moving more of their assets (e.g. taxable, tax-deferred) into investment advisory—and we expect that trend to continue.
We recognize that an investment advisory program with ongoing advice from a financial adviser is not the only solution for all retirement clients. Our retirement brokerage account clients who prefer not to receive advice from a Merrill Lynch Wealth Management adviser will have a choice to use a range of investment options—from self-directed brokerage to online guided investing—through Merrill Edge. We will provide additional pricing flexibility to help clients with transitioning from brokerage retirement accounts to our Investment Advisory Program.
Rhonda L. Ducote
President/Principal
Apriem Advisors
Irvine
The fiduciary rule will take effect in a few short months, and when it does, the measure will greatly benefit consumers. Gone will be the days when unscrupulous brokers put their clients into investments they did not necessarily need just because the broker wanted the commission or was trying to unload someone else’s positions.
Starting in April, all financial advisers will have to act in the best interests of their clients. At Apriem Advisors, we’ve always carried a fiduciary responsibility, being fee-based rather than commission-based, so the rule change will not affect us in that regard.
However, we do expect the change to make our space even more competitive, since our advantage of being an independent, registered investment adviser firm dedicated to solely serving our clients may become the “new normal.”
By that same rationale, though, financial advisers will gain an advantage over the emerging class of so-called robo advisers, which have gained more than $20 billion in market share over the past few years. If someone was thinking of investing with one of these internet-based financial management systems, which allocate your savings based on algorithms and a brief questionnaire, that consumer will likely think again, once the trust of human advisers is restored with the help of the fiduciary rule.
There is a place for automated allocations. Such tools can work well for a young professional who is first starting to amass wealth and does not yet own many hard assets, such as real estate. He or she might be looking for the simple diversity that a robo adviser provides, but for those who are 50 and older, their lives and mix of assets are much too complex to leave in the hands of a computer. Such a portfolio requires frequent communication with experienced advisers who are focused on clients’ well-being. That personal touch is more important now than ever.
Rick Keller
Chairman of the Board
First Foundation
Irvine
The new fiduciary rule will have a very positive outcome for the consumer. The average consumer has not necessarily had access to the best and brightest advisers, especially consumers with smaller accounts. The conflicts of interest and lack of disclosure by investment salespeople have sometimes led to egregious violations of trust and substantial loss of capital/principle for investors. For instance, some annuities sold into IRAs with very high commission rates and fees are far more favorable to the salesperson than the consumer.
Also, we’ve seen mutual funds with high sales commissions attached to them and 12B-1 fees gobble up performance over long periods of time. This won’t correct all egregious behavior but will substantially limit it. It will still be up to consumers to do their homework to limit fees and expenses in handling their 401(k) and IRA retirement needs. Although, investment advisers providing advice on retirement plans and IRAs will be required to have a best-interest contract with each client.
The final regulations of the new rule are expected to be issued early next year, with phase one of the rule beginning on April 10 and full implementation starting Jan. 1, 2018.
Robo advisers have taken center stage lately, given attributes that resonate, particularly with the mass affluent, tech-savvy investors. There is a perception that these solutions are offering high-quality investment advice at a lower cost, yet we believe this still has to be proven out. Over time we will see how different market cycles impact these online investment offerings.
Kevin O’Grady
President, Co-Chief Investment Officer
Palo Capital
Newport Beach
This new rule is making many investors realize for the first time the distinction between financial advisers who operate under the fiduciary standard and those who do not. Fiduciary advisers are required to place the client’s interests first. Shocking as it may seem, the majority of advisers operate under a lower standard, which allows them to sell financial products that are more in the adviser’s interests than the client’s due to commissions or high embedded fees. Even prior to the new rule, there has been a shift of assets away from traditional brokerage firms that generally have not operated as fiduciaries, to registered investment advisers, most whom are fiduciaries. The new rule is accelerating this shift. Because Palo Capital was created to manage “friends and family” money, there was never a question that we would choose to operate as fiduciaries. When friends ask me about financial advisory services, I tell them “whatever you do, choose a fiduciary adviser.”
As to active versus passive investing, this topic is too often presented as an either/or matter. There are certain investor objectives that are better suited to active, while others are better suited to passive. There are parts of the market cycle that favor active and parts that favor passive. That said, there are many active managers whose performance does not justify their fees relative to passive options (which also entail fees, albeit lower ones). At Palo Capital, we are an active manager in our core equity strategies, but we also make extensive use of passive vehicles.
Robo advisers are gaining traction with younger investors with smaller accounts, where this approach is often cost-effective. Among more affluent investors, there are usually enough issues at play (taxes, trust vehicles, etc.) that the advice and service that a good investment advisory firm can provide make a lot of sense. Good advisers can help clients avoid the behavioral finance traps that cause most investors to do significantly less well over time than the market averages. It will be interesting to see to how robo advisers are able to address this need.
Scott M. Parent
President
Pacific Specialty Investment Group LLC
Irvine
My opinion is based on my 21 years in the business, first working as a portfolio manager for a fee-based investment advisory firm and now owning my own fee-based investment advisory firm. My comments reflect the impact that the new fiduciary rule and the trend towards robo advisers will have on myself and other fee-based investment advisers in Orange County. As an aside, we do additionally offer performance-based investments to our clientele but do not offer commission-based products.
The new fiduciary rule and the recent trend toward robo advisers were born out of one primary good intention: to protect investors from high fees, which is a definite positive. So while the new rule and the use of a robo adviser would definitely help a certain subset of investors, namely younger investors with less sophisticated needs, I believe it can actually harm other investors. There is a significant portion of investors in Orange County that desire and expect custom portfolios, alternative investments, active management of their portfolios, and a trusted relationship with their adviser. How is it possible to provide all of these valuable services at robo adviser prices? The whole purpose of the rule is to prevent conflicts of interest and to try and ensure that investments are made in the best interest of the client. Doing what is in the best interest of the client is our No. 1 goal as investment advisers. But to provide a diverse investment mix, the extensive amount of time it takes to understand your client and their needs, and give the client the high level of service they deserve, makes it difficult at rock-bottom prices. And just to be clear, the fee-based advisory business is so highly competitive, it is already a low-margin business.
The regulatory environment just continues to become more and more onerous and is risking forcing investment advisers to provide less service, less sophisticated products, less time with our clients, all so we can afford to stay in business at low-ball fee rates. Now, I am in complete agreement with the new rule in terms of high-commission products. A hard look should be taken at products being sold with large upfront commissions—for instance, variable annuities or other high-commission tax-deferred products being sold to ERISA/IRA investors whose accounts are already tax deferred. But the rule is so broad in my opinion that it puts an extreme burden on the adviser to change our investment offerings—even if we and the client think those offerings are in their best interest—because we fear the regulators may not agree. Additionally, we would have to lower our fees to some arbitrary low standard similar to a robo adviser while still maintaining all of the services and high standards our clients hired us for. Not easily achieved.
The investment advisory business is not only about building wealth and financial security for our clients; it is about building relationships and knowing our clients. The only true way to know your client and build a portfolio in their best interest is to know them on a personal level through phone calls and meetings, something a robo adviser can’t do. There have been countless times I have received an initial fact finder and risk questionnaire back from a new prospect and then met with them, only to realize how different they are from how they appear on paper.
The bottom line is that fees are only one of many factors why someone would choose an investment adviser. For higher-net-worth clients who have a more diverse set of needs, which may include financial planning, estate and tax planning, actively managed accounts, and alternative investments, I don’t see the benefit of a simplistic robo adviser approach—although I do see the value for clients with smaller portfolios who don’t require the above-listed services. As for the new fiduciary rule, protecting ERISA/IRA investors from paying commissions on products that may not be in their best interest makes a lot of sense. I just fear the impact that the new rule will have on fee-based advisers and our ability to still maintain our high levels of service and customization while being pressured to compete with robo adviser pricing that doesn’t provide any of those services. Time will tell.
E. Dryden Pence III
Chief Investment Officer
Pence Wealth Management
Newport Beach
At Pence Wealth Management, we believe there is certainly a place for passively managed portfolios that replicate indexes. They can work well for those who have a very long time horizon and can invest their money and forget about it for a long while. The challenge is that portfolios that replicate indexes have now become so dominating that they can almost be a proxy for panic. The idea that indexes may dampen volatility may be losing its validity as more and more individual investors use them, and as more and more people are working without an adviser, there is no one to tell them to breathe, think, and not to overreact. They just jump in and out from euphoria to fear, and when they do it with indexes, it only tends to exacerbate volatility.
We welcome the fiduciary rule. As fee-based, full-discretion financial advisers, we have focused on the fiduciary standard of care for almost two decades. We think it is imperative that advisers put clients’ interests ahead of their own. The old standard of suitability meant that the adviser just needed to recommend something where the client could either withstand the loss or who was sophisticated enough to figure out the risk on their own. The fiduciary standard requires an adviser to know the client well enough to know what is appropriate for them, given their particular set of circumstances. It involves a higher standard of care and requires an ongoing duty to provide advice and monitoring. It forces advisers to know their client better, and that is best for everyone. What is interesting is that the idea of a fiduciary seems at odds with the notion of robo advisers. Computers can do wonders to simplify and drive down the cost of advice and execution, but I am not sure a computer can read a client’s body language in a meeting and ask the right hard questions, the ones that could make a difference in their lives and families. Robo advisers may be great for investors just starting out, and we intend to integrate it, but when planning gets complex and life happens, people need advice from experienced professionals who can help them navigate the mine fields of real reality, not virtual reality.
Ryan Serrecchia
Executive Vice President, Partner
EP Wealth Advisors
Irvine
The Department of Labor’s ruling was meant to protect consumers and level the playing field by reducing fees, preventing egregious sales practices, and holding advisers accountable as fiduciaries within retirement accounts like 401(k)s and IRAs. Life insurance, annuities, mutual funds and other broker dealers will have to advise in the best interest of the investor as a fiduciary, which increases the legal liability of investment advice. However, this is not new for registered investment advisers like myself and my team, as we chose to hold ourselves to a fiduciary standard prior to the ruling.
Unfortunately, one side effect of the ruling may be smaller investors becoming even less attractive for the industry because of the likely increase of legal costs relative to the profitability of those smaller accounts.
Interestingly, robo advisers were considered fiduciaries in the ruling, primarily because of their use of low-cost index funds, and we should see acceleration in their success as a result.
While smaller investors will get cheaper, well-diversified portfolio allocations, they won’t get the personal help and hand holding they may need. Investing can be incredibly emotional for most individual investors—just look at the work of behavioral economists (or even Warren Buffett’s mentor, Ben Graham) which shows that investors tend to panic and do exactly the wrong thing in market cycles—selling at the bottom and buying at the top of the market.
Betterment, one robo adviser, suspended trading on the heels of the Brexit vote to prevent this sort of rush to the exits. But it was without communication, so many investors were angry and confused.
It has been proven that having a plan and sticking to it will actually make a difference for investors in the long run, though it’s hard to stick to the plan without someone there to talk you through the difficult market swings.
The truth is that the wealthier investors won’t be nearly as affected and will still be able to get personalized financial and investment advice, though they may learn a thing or two about the commission they pay the advisers who they work with.
Rafael de Vengoechea
Financial Adviser
Global Wealth Management Division of
Morgan Stanley in Orange County
Newport Beach
Morgan Stanley financial advisers across the industry are working to understand how the Department of Labor’s new rule governing retirement accounts, such as IRAs, will affect their service models. The rule was drafted to allow investors to pay for services both by commissions on transactions and via a fee that’s based on the size of overall account assets. It remains to be seen whether this client choice will be preserved in the way individual firms choose to implement the rule.
Passive index funds and robo platforms can provide a low-cost alternative for investors just starting out or who have basic investment needs. High-net-worth investors who have complex needs for asset diversification, credit and liability management, estate planning and family governance policies involving multiple generations still tend to gravitate to a human adviser who can help pull all these pieces together. I work with my clients to develop an investment plan that meets their specific needs; they appreciate that I work with them to save for the down payment on their first home, send their children to college, and finance their retirement.
Jonathan Wallentine
Chief Executive Officer
Actuarial Management Co.
Laguna Niguel
The financial services industry spends millions each year in Washington, D.C., to prevent laws requiring them to act in the best interest of their clients. And now, one battle has been lost. The new fiduciary rule makes it illegal for financial advisers to swindle clients in certain situations, ones that involve retirement money. The change will drastically improve the industry’s ability to serve the public, and I’m extremely excited about it. I’m passionate about the topic of acting in the best interest because I used to develop the very products that allow financial advisers to exploit their clients, such as life insurance, annuities and mutual funds.
While creating these products, I struggled with the morality of engineering them for an industry I knew had lost its way. Now, under the new law, many of the products I once created will be illegal in many situations, and rightfully so. The bulk of the problem is attributable to commissions and kickbacks built into the products that create conflicts of interest between the financial adviser and their client. Why? A financial adviser has a big incentive to recommend the products that pay him or her the most, whether or not they are really best for the client. Incentives are fine when we’re talking about hamburgers or used cars, just not retirement and financial security. McDonald’s employees don’t call themselves nutritionists, and used-car salesmen don’t call themselves transportation consultants. In my opinion, the very fact that commission-based salesmen call themselves financial advisers is borderline fraud. Advice is defined as “guidance or recommendations concerning prudent future action.” Since the products financial advisers recommend are not prudent in many cases, what we have is an entire industry purporting to be something it’s not, by definition. Think about that: The very title they represent to the public is a lie more often than not.
The trends towards passively managed/indexed funds and robo advisers are simple to explain. We are in the midst of the information age, where it’s becoming more and more difficult to generate profit margins based on an information advantage. I go into extensive detail regarding these changes in my book, “Cloning Wall Street.”
