Morningstar Investment Conference: Practical Advice for an Evolving World

The Wrong Battle Yesterday, the 2016 Morningstar Investment Conference commenced, thunder-free. (If you attended the past few years' events, you will understand.) The first panel addressed how investment advice is changing. Two financial advisors and authors, Blair duQuesnay and Bill Bernstein, joined Morningstar's Don Phillips for the discussion. Christine Benz moderated.

Indexing, naturally, drew much attention. While praising the quality of the better (meaning, lower-cost) index funds, Phillips bemoaned the “civil war” that has taken place between those who advocate active investing and those who favor the passive approach. For Phillips, this is a faux debate because what really matters is cost. As he pointed out, even indexing pioneer Jack Bogle concedes that a low-expense active fund is superior to a high-cost passive fund.

For Phillips, this civil war has led to collateral damage. Millions of Americans who should be investing in stocks and bonds are abstaining, in part because they have been frightened away by fund companies’ negative campaigns. (Active management harms an investor’s financial health; indexing is a form of market bubble.) Increasingly, he said, the middle class “thinks of investing as an activity of the top 1%.” Those who sell passive funds have increased their share of the pie, but they have not enlarged that pie.

Bernstein and duQuesnay do not share Phillips’ concern about fund company rhetoric, but they agreed that the active/passive discussion should be reframed. The “real cleavage is between high-expense funds and low-expense funds,” said Bernstein, although he cautioned that the term “expense” includes trading costs in addition to the fund’s officially reported expense ratios. There aren’t many active funds that are cheap on both accounts. For her part, duQuesnay stated, “The reduction in cost is the main advantage of indexing.”

Automatic Improvement All three panelists were enthusiastic about the growth in automated investment advice, although they each gave different reasons.

Once again, Bernstein cited cost. That so-called "robo-advisors" can serve a $10,000 client for 30 to 50 basis points (that is, 0.3% to 0.5%) per year is a boon for smaller investors. (As this column pointed out a few months back, The Wall Street Journal's op-ed staff vehemently disagrees.) Better yet, said Bernstein, thrifty shoppers can buy an appropriately dated Vanguard target-date fund, "which does pretty much what robo-advisers do, at 14 basis points."

DuQuesnay finds automation to be an important timesaver for her younger clients. Investing in employer-sponsored plans, such as 401(k)s, is simple. But establishing other retirement accounts is not. Her clients get bogged down while trying to set up such accounts and often fail to fund them consistently. Any technology that streamlines the investment process is invaluable. “Setting up the automated-savings process is more important than selecting the investments themselves,” she concluded.

As does Bernstein, duQuesnay believes that investments can contain bundled advice. One possibility is longevity insurance, which is a deferred annuity. The annuity does not pay immediately after being purchased. Instead, it postpones its payout until well into the future--say, on the investor’s 85th birthday. Thus, those who build financial plans that are expected to last until age 85 (a typical date) now have protection should their physical health be strong and their financial health weak.

At this stage, duQuesnay is “interested” in longevity insurance but has not yet recommended it to her clients, as she needs to study it further. Bernstein is skeptical. He believes that longevity insurance is priced attractively for the insurers but less so for their consumers, so that the rate of return will be low. He also is concerned that the service offers only limited inflation protection.

For his part, Phillips believes that automated advice’s best use might be as support for conventional advice. “We are all in the behavior-modification business,” he said. “Getting clients to act counterintuitively is where we add value.” Automated programs that enforce the habit of putting more money into the markets during the rough times when clients wish to redeem or programs that rebalance portfolios by moving assets from stronger-performing funds clients like to the weaklings they loathe are very helpful.

Best Interests The panelists were mostly--but not entirely--pleased with the Department of Labor's new fiduciary standards, which govern the retirement-related accounts that are under the DOL's jurisdiction (but not other investment accounts, which are governed by the SEC.) Those who give advice on such accounts must henceforth to do in the client's best interest, rather than merely meeting the lower standard that the advice be "suitable."

Said duQuesnay, “We’re halfway there.” The financial-advisory industry began as a “salesforce business, not as a profession.” It has been a long process to wrest the industry away from its product-pitching roots so that financial advice can become fully professional and be trusted by those who receive it. The DOL’s new standards are a step forward, and the SEC will likely follow suit because its “hand has been forced.” However, the industry still needs to sort out its “alphabet soup” of credentials in order to avoid consumer confusion.

Phillips believes that the bright cloud has a dark lining. Yes, of course, financial advisors should operate in the best interests of their clients. It was probably a necessary step to specify that requirement. But now the legal floodgates have been opened. Lawyers, accountants, and doctors are more respected by the public than are financial advisors. But the former often face crippling lawsuits. Financial advisors may be next on the list--and that may force them to make suboptimal investment decisions for reasons of legal safety.

Bernstein will take that chance. Assume that the new legislation does indeed cause investment advisors to herd for legal protection so that they put their clients mostly into bland market-index investments. What’s wrong with that, Bernstein asked? “If everybody owns the market portfolio at a cost of 0.05% per year, 95% of investors would be better off under that future than they are today.”

Note: I promised 10 days ago that I would be writing a column about the tax consequences of owning funds versus stocks directly. That column has not yet appeared and will not happen this week because of the Morningstar Investment Conference, but it will be forthcoming. (Whether you wish it or not.)

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.