How the Fiduciary Rule May Cause a 'Disruption'

This analyst blog is part of our coverage of the 2016 Morningstar Investment Conference.

The U.S. Department of Labor's fiduciary rule is likely to challenge many established business models in the financial-services industry. The rule seems simple enough in its aim--ensuring that broker-dealers, 401(k) plan providers, and other retirement advisors are acting in their clients best interests--but questions and complexities surrounding the rule's implementation remain.

In fact, as Morningstar senior analyst Michael Wong recently pointed out, we've already seen the exit of several foreign banks (Barclays, Credit Suisse, Deutsche Bank) from the U.S. wealth management landscape; sale of life insurance retail advisory businesses (AIG, MetLife); and restructuring of wealth management platforms (LPL Financial, RCS Capital, Waddell & Reed) in anticipation of the rule.

In the panel "The Fiduciary Rule and the Future of the Industry" at the Morningstar Investor Conference, Wong, Anthony Serhan, managing director of research strategy-Asia Pacific, for Morningstar Australia; Tricia Rothschild, head of global advisor solutions for Morningstar; and Paul Ellenbogen, director of global regulatory solutions for Morningstar, discussed just how far-reaching the effects of the new rule could be.

The rule, which primarily affects advised retirement accounts, could be very widespread, affecting as much as $3 trillion of full-service wealth management assets. Its effects could also bleed over into how taxable accounts are managed and serviced, Wong said.

As Serhan pointed out using data from 25 countries sourced from Morningstar's Investor Experience Report, this best-interest standard is already being propagated throughout the world.

Rothschild pointed out that one of the major shifts we will see is the focus moving from the product to the person. Structurally, the industry is evolving to put the client central to the equation, which puts an emphasis on financial planning and finding out more about the client. After all, it will be difficult to prove you are acting in your client's best interest if you don't know your client's goals.

"Over several years, it will cause a shift in the industry to the person. That's the value," Rothschild said.

Rothschild believes the change to client advice will necessitate something she calls a three D solution: determine, demonstrate, document. The last step is crucial, she points out--advisors will need to beef up documenting because of increasing scrutiny. The client's interests at heart, the challenge is being able to come up with the right data sets to support that decision.

The upshot will be increased transparency, said Serhan. "You have to be adding value to your clients. If you're not, you are going to come under pressure."

Wong noted that alternative-asset managers and life insurance companies may be challenged in the years ahead, as the focus will shift to finding the best products to provide the desired outcome for your client.

"When you are trying to determine the best interest of your clients, you have to balance return versus cost," he said. In his analysis, higher-cost investments are going to lose out, because advisors will have a harder time substantiating why they make sense. In contrast, he foresees a lot of money moving into cheaper passively managed products such as ETFs and index funds.

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