WF: One of the biggest regulatory changes that US fund distribution is facing currently is the implementation of DOL's fiduciary guidelines for retirement advice. Can you please walk us through the DOL regulation, how this changes the lives of commission based advisors and how they are adapting to it?
Tim: Yes, its been a key part of our lives for the last 2 years with all the speculation around the regulations, the input into it and so on and now we move into execution as the regulation went live in June 2017, with an effective date from January 2018. The DOL regulations deal with fiduciary responsibilities for advisors dealing with retirement accounts. In essence, the aim is the prevent any conflict of interest that may arise - and therefore there are now heightened disclosures - all commissions, all fees must be adequately disclosed to investors. So there is a higher level of accountability for advisors than what was prescribed under the suitability standards that were applicable for commission based advisors. Many advisors, particularly the fee based ones, were already under fiduciary obligations, but for commission based advisors, this is quite a significant change.
Implementation is still a few months away, but at the centre of most discussions is the execution of a "Best Interests Contract" as mandated under the new regulations. There is still a lot of confusion around this and many firms are in any case reluctant to sign such contracts with all their clients. So what we are seeing playing out ahead of actual implementation is that many advisors are choosing to migrate to platforms where they can put all assets of each client into separate accounts which will hold all their funds, ETFs, IRAs, stocks, bonds etc - and then charge a wrap fee on the account. That's the simplest way to comply with the new DOL regulations.
WF: Would it be correct to say that the basic difference between suitability and fiduciary standards is that in suitability, the advisor's responsibility is primarily to determine suitability of the asset class and not the actual product while in fiduciary, he is responsible for ensuring that the specific product being recommended is indeed in the investor's best interests?
Tim: Yes, you've hit the nail on the head. Under the fiduciary standards, the advisor needs to review the fee structure of the product being recommended and make sure that it is appropriate and in the investor's best interests.
WF: Is there any move in the US to try and demarcate lines between commission based distributors and fee based advisors in terms of what they can and cannot offer to their investors? We have in India, a proposed regulation which explicitly states that if you are a commission based distributor, you cannot offer risk profiling, financial planning and any such services that can be construed as advice and that you must restrict yourself to only basic product description related services - like what distribution looked like a couple of decades ago.
Tim: No, I don't think there is any such regulation in the US. The DOL regulation will I suppose move more advisors towards a fee based model. But no, we don't have a set of don'ts for commission based advisors - that would be pretty challenging to work through, given what investors expect in this day and age.
WF: We struggle in India to get young blood into the profession. Is this a challenge in the US too?
Tim: Yes, we too struggle to help young people understand the potential in the advisory profession. That apart, we are also struggling with some other dynamics - we have far fewer women advisors than are required and are unable to attract as many as are really required. As more women control larger proportions of wealth, there is a need to have many more women advisors than we currently have.
WF: As markets move into high valuation zones there is always a worry about whether fund sales teams and distributors are pushing the pedal too hard on sales when they perhaps should be attempting to rein in vaulting investor expectations. How do you tackle this challenging situation in your business?
Tim: One of the things I have picked up in India is the prevalence of SIPs as the lead proposition to get individual investors into equity funds. That is clearly the best way forward - to encourage long term systematic investments rather than lumpy allocations based on perceptions of where the markets are heading in the near term. Its frankly not as popular in the US for after tax dollars as it is in India. As you know, systematic investments are an intrinsic part of the 401(k) plans that people set up for their retirement accounts. But when it comes to after tax dollars beyond the 401(k) contributions, we have more work to do in terms of encouraging a more systematic approach to investing that.
WF: The US has seen significant growth in absolute return hedge fund strategies on one hand and passive ETFs on the other, with actively managed funds being the biggest casualty in the bargain. Is this trend likely to continue? How do you see investor preferences for products evolving over the next 5-10 years and what will be likely implications on the fund management and distribution businesses as a consequence?
Tim: This is a central part of the conversations we have currently in our firm, in our industry. Flows into passive ETFs have risen sharply, at the expense of core actively managed equity funds. Alongside the move towards passive ETFs is a preference to go direct with them. Absolute return products elicit a lot of interest in terms of conversations, but flows aren't yet very large. What is picking up however is flows into products that feed into real assets - like real estate related funds for example.
What's also gathering momentum is the move towards outcome oriented solutions in preference to individual products. People who want to generate regular income are going towards solutions that are designed for this outcome, and they are less focused on whether the solution is allocating to high yields or preferreds or emerging market debt and so on. What they want is consistent income with low volatility - and the fund managers therefore spend more time in putting together portfolios that achieve this outcome. We therefore spend a lot more time on multi asset strategies that are designed to deliver to a range of outcomes that investors are looking for.
This ties in well with what advisors are looking for. As margins shrink, advisors are looking for more scalable models without compromising the interests of investors. They realise that they may not be able to, going forward, create individual portfolios and monitor them as closely as they were doing in the past, in a lower margin environment. Outcome oriented solutions are a good option for them as they review a variety of solutions, select what they think is most appropriate for their clients and then let the solution do the rest for their investors.
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