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The National Economic Council: Let Investors Eat Junk!

The arguments against the Department of Labor’s fiduciary rule grow ever stranger.

John Rekenthaler, 02/15/2017

Investment Calories
Technically, Gary Cohn was no longer president and chief operating officer of Goldman Sachs when he made his statement, having resigned his duties in January to become director of the National Economic Council. Thus, despite my fervent desire, I couldn't entitle this column: "Goldman Sachs: We Sell Junk."

Ah, well. It's still a doozy of a quote. Arguing against the Department of Labor's fiduciary rule, which was passed in 2016 and scheduled to be enacted in 2017, Cohn said, "This is like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn't eat it because you might die younger."

In other words, brokerage firms like Goldman Sachs that must change their practices to conform to the new rule, are doing the financial equivalent of dropping junk food from the menu. Which implies, of course, that they now sell such fare.

Well, that's a remarkable admission.

Indexing, Indexing Everywhere
Exactly what Cohn was confessing to, I do not know, because the department's rule does not directly address investment policies. Rather, the rule covers pricing: the possibility that because different investments carry different commissions, that brokers may be tempted to consider what benefits them when recommending investments. Under the fiduciary rule, that is not permitted; all sales must be in the clients' best interests.

Most likely, what Cohn means is that the rule will encourage the greater use of index funds, for two reasons. First, more financial advisors will switch from selling load funds to charging asset-based fees. As investors are much more willing to hold index funds in asset-based accounts than they are to pay a load charge when buying an index fund, the change in payment structure will likely lead to more indexing. Second, the fiduciary rule creates additional legal concerns, and indexing tends to be a safe approach for avoiding lawsuits.

Nothing new there. Indexing is already eating active management's lunch. Now perhaps, aided by the fiduciary rule, indexes will also gobble down dinner. That's good for those who manage index funds, bad for those who do not. But that shift doesn't eliminate items from the investment menu, as Cohn implies. It affects the mix of orders placed by the customers, but not the choices that are available.

Against Best Interests?
Cohn's exact meaning eludes. What is crystal clear, however, is the statement's spirit: that brokerage firms shouldn't be required to do the right thing for their clients.

is vice president of research for Morningstar.

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