GuidePost - Vol. 3, Issue 2 2007

The GRABot BAG
by Sherrie E. Grabot, CEO

March 2007
Fund managers can now give investment advice — but will they?

Killer snowstorms, tornados, hailstorms, and mudslides. Stock market wobbles. Alan Greenspan (isn't he supposed to be retired?) talking about a possible recession later in the year. And closer to our specific areas of financial concern, the nation's savings rate at a record low not seen since 1933. It's adding up to a pretty rough winter.

The good news? The seismic shift in retirement plans triggered by the Pension Protection Act is still rumbling across the land, and it's shaking up the business of investment advice. The latest tremor comes in the form of a guidance bulletin from the DOL regarding fees, among other things.

FAB federal regulations
In the last issue, we offered a detailed legal opinion on how the Pension Protection Act is likely to affect bundled investment advice, automatic enrollment, and default accounts. The real-world impact of the act, of course, will depend on how regulators interpret and clarify various points of law, and on how the industry and the market respond. We're starting to see both happen.

On the regulatory side, the DOL issued a Field Assistance Bulletin (FAB) recently to clarify the Act's effect on prior rules for investment advice, selecting and monitoring an advice provider, and the issue of "level fees." For the legal eagles among you, the original text of the bulletin spells out the details, with footnotes. For the rest of us, the key fact is that firms will now be able to offer advice directly while charging varying fees for their funds. This seemingly opens the door for the big players to offer their own advice, and could pull the rug from under independent providers.

House-label or independent?
Will it? Like most answers, this one's a little complicated, so let's look at the details for a moment. The old rules let managers give advice regarding their own products, but only if they charged the same management fees regardless of which funds investors chose. This forced big firms to rely on independent investment advisors - and according to a recent article in Investment News, led at least one to lobby Washington intensively for a change.

The new DOL guidance lets managers have it both ways, with a catch: the actual fiduciary advisor (an individual or a corporate entity) must still receive "level fee" compensation. As Investment News rather delicately put it, "with the new guidance, the need for those advice middlemen has diminished." So, are the big management companies going to set up their own advice services right away and drop the independent firms?

We don't think so. Industry spokesmen don't say much either way; they admit they're looking at all their options, but stress that they value their existing relationships. Behind the PR, however, there are at least three good reasons to think this business isn't going to disappear anytime soon.

Independence. Being an "independent advisor" doesn't just mean that we aren't owned by a big management firm (and in fact, some of our competitors actually are). It means we're truly independent, third-party, objective investment advisors. This independent perspective provides an immensely valuable foundation of trust for the plan participant, and prevents any appearance of conflict of interest for the management firm. As the scope and influence of huge financial firms grows ever larger, we believe independent advice may actually become more important in the future (at least in the large-plan market, where sponsors have the leverage to get exactly what they want).

Buy or build. Business is full of contradictions. A large corporation can hire thousands of employees and acquire hundreds of smaller businesses each year, while at the same time farming out critical tasks to vendors and contractors. Now that fund managers can choose whether to buy or build advice services, their choice will depend on the usual array of business considerations. Given that strong fiduciary requirements for independence and compensation still apply, it's a good bet many firms will find it easier to leave it to specialists as long as they deliver the goods efficiently.

Efficiency. Which brings us to the perhaps the key success factor under the new order, efficiency. As long as the independents can deliver quality advice more efficiently and with greater value, they should still prosper. The only difference is that instead of choosing among competing advisors, clients can now choose "none of the above."

The heat is on
This certainly turns up the heat on advisory firms, but it's just the kind of benign market pressure that that drives progress. With a wider range of options available, the market will be more demanding about things like efficient delivery systems, better user experiences, managed accounts, new investment solutions, and of course, lower fees. All in all, the competitive landscape should continue its evolution from "traditional" financial services to a more innovative, responsive, consumer-focused environment.

This is good news for everyone. The DOL's decision does make life easier for large management firms, but the likely results will support the overall intent of the Pension Protection Act by providing better ways for Americans to build retirement savings. The bottom line is that quality investment advice will be easier to get for the average plan investor. And ultimately, that's whom fund managers, fiduciary advisors, and the government should all be working to serve.

~~ Sherrie