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The Effect of a Best-Interest Standard on Asset Managers

Trimming product shelves, moving beyond the pitch

Morningstar Staff

 

New regulations have accelerated the trend of best-interest advice in markets worldwide. And in the U.S., in response to the Department of Labor’s fiduciary rule, an increasing number of financial advisors are adopting this standard, changing the way they select financial products for their clients.

For their part, advisors have begun to determine, demonstrate, and document that their advice is in the investor’s best interest. And asset managers are adjusting to new broker/dealer compensation models, creating new marketing materials that tell a portfolio-focused story, and managing their fund lineups to maintain their presence on product shelves.

Broker/dealers are figuring out the future of distribution

Avoiding conflicts of interest in commission-based accounts means some broker/dealers and Registered Investment Advisers (RIAs) are moving exclusively to fee-based accounts. Some broker/dealers and RIAs may continue to support commission accounts by developing best-interest proposal workflows for both account types.

For the full Best Interest Contract Exemption model, the market has the newly created T share. It’s a share class type that pays an advisor a 2.50% front-end commission and an ongoing fee of 0.25% per year. Compensation to the advisor is level across funds, removing the commission incentive to steer a client toward a fund that may be inappropriate.

What a best-interest standard means for broker/dealers

Firms are moving to cut offerings that don’t demonstrate a clear best-interest standard. While some brokerage firms are outsourcing the job, those who manage their product shelves hands-on will likely need long-term support and quantitative metrics throughout their due diligence process. Independent research from a third party can go a long way toward proving best-interest standard.

The proposals advisors prepare need to communicate the value of their advice and how it works for each client. Advisors need to determine a client’s current situation, demonstrate whether a change is in the client’s best interest, document the change, and explain why it is being made. It’s typically a six-step process that looks like this:

  1. Gather client data.
  2. Assess a client’s needs and determine their goals.
  3. Analyze and model portfolios and create proposals.
  4. Build asset allocations and select investments.
  5. Conduct best-interest due diligence.
  6. Open accounts.

Asset managers are adjusting to this best-interest standard

Though the fiduciary rule makes a clear regulatory case for lower-cost products, it’s also an acceleration of existing trends. Asset managers need to see themselves through a distributor’s perspective. The new standard forces asset managers to re-evaluate the performance/fee equation and reconsider their strategies.

This means shifting from a product-driven, transactional approach to a holistic view of clients and their portfolios. Asset managers will likely need to act more like consultants, giving financial advisors the support that helps them justify investment choices in the best interest of each client. It isn’t enough to just pitch products anymore.

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