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Does Load-Sharing Still Hurt Investor Returns?

Our analysis shows regulations prompted advisors to rigorously screen on performance

Jake Spiegel


In 2015, the Labor Department proposed the “fiduciary rule,“ a regulation aimed at mitigating conflicts of interest in investment advice and ensuring that brokers acted in the best interests of their clients. Although the 5th U.S. Circuit Court of Appeals struck down the Labor Department’s final rule last spring, in April the Securities and Exchange Commission proposed a new standard of conduct similarly aimed at addressing conflicts of interest.

These proposals come at a dynamic moment, one in which business models have been changing rapidly on their own, and the response to the Labor Department’s erstwhile fiduciary rule spurred big changes for broker/dealers, advisors, and asset managers.

How load-sharing can affect investor returns

Historically, a key conflict of interest that could distort brokers’ recommendations stemmed from load-sharing arrangements. Here’s how these arrangements work: If Fund A and Fund B are similar in terms of asset allocation and performance, but Fund B shares more of its load with brokers, then brokers have an incentive to sell Fund B to their clients.

An academic paper, written by Susan Christofferson, Richard Evans, and David Musto, whom we will refer to as “CEM,” explored how this particular conflict of interest hurt investors. The paper served as the key source of empirical evidence for the Labor Department in justifying the fiduciary rule and found that funds that paid brokers higher loads tended to see worse investor returns.

One of CEM’s more significant findings was that for every 100 basis points in higher-than-expected loads, future investor returns were reduced by about 0.34%. However, since CEM’s data ended in 2009, market trends might have altered the relationship between loads and flows. Since the SEC is considering picking up where the Labor Department left off, with Regulation Best Interest, we wanted to see whether there was still evidence that load-sharing hurt investors’ performance.

Brokers have been screening funds more carefully over the past decade

To see if funds that paid brokers higher-than-expected loads still saw worse investor returns, Morningstar’s policy research team built on CEM’s paper and extended the analysis to include data from 2010 until 2017. We replicated the methodology used by CEM, and combined Morningstar’s own data on fund performance, flows, and other characteristics with public filings collected by the SEC to update the analysis.

Our analysis suggests that brokers and advisors are more rigorously screening funds on performance when making recommendations to their clients. Once we accounted for a fund’s past performance, we saw that higher loads have not been associated with worse returns for investors in a statistically significant way since 2009.

There are ways investors could be harmed by loads dictating fund flows other than seeing worse performance. For example, we still saw a strong effect on flows from unusually high load-sharing arrangements. However, our analysis suggests that one avenue of investor harm—smaller investor returns as a result of investments flowing to worse-performing funds that paid brokers higher loads—has been largely mitigated.

Going forward, we hope regulation will maintain positive trends for investor returns

The proposal of the fiduciary rule was a signal from regulators that potential conflicts of interest in advice were going to be more closely scrutinized going forward. It has since been vacated by the courts, but the SEC’s Regulation Best Interest is an indication that regulators are still interested in conflicts of interest.

Advisors and brokers have screened funds more rigorously since 2010, at least on the basis of performance, but they only recently stopped recommending funds to clients based on load-sharing, our paper reveals. Further, this shift was in direct response to the Labor Department’s proposal. So, the billion-dollar question for advisors: Is more regulatory pressure required to sustain the shift in business model, and will the SEC rule provide such pressure? We think with a few changes—which we suggested to the SEC back in August—the SEC could maintain the trend of advisors putting their clients’ interests ahead of their own.

Learn more about how Morningstar helps advisors deliver best-interest advice.

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