Here’s an article written by CFA Insitute describing Morningstat’s analysis of the DOL Rule and the industry.
By Jim Allen, CFA
Washington, DC, is known—and regularly scorned—for its role in picking winners and losers through its legislation and regulation, a stigma that dates back centuries. So, it should come as no surprise that the Department of Labor’s (DOL’s) fiduciary duty rule, one of the most sweeping regulatory changes of recent decades, is widely expected to help some existing players while hurting others. Although the rules don’t involve direct infusions of money into the winners, it is expected, nevertheless, to produce changes in the way significant sums of investor money are invested.
Morningstar, a Chicago-based rating agency, has thoroughly assessed the new rules and determined that it will produce three primary trends.
First, it will shift customers from commission-based arrangements to fee-based structures, which is estimated to increase industry revenue by $13 billion.
Second, robo-advisers will likely pick up a large percentage of the $600 billion in low-net-worth IRA balances currently held by full-service wealth managers.
Third, it could lead to a significant increase in the use of passive investment products.
In aggregate, Morningstar predicted that $3 trillion in retail client assets are at stake, relating to $2.4 billion in fee revenue. That is more than double the $1.1 billion in compliance costs the industry estimates will be needed.
The Winners and Losers
On the basis of these trends, the rating firm concluded the rule will favor those engaged in discount brokerage as well as those selling exchange-traded products and index funds. By contrast, life insurers and alternative asset managers are seen as the likely losers. Their high commissions and vertical integration are the areas Morningstar believes will create the problems for insurers.
“[W]e believe that companies that rely heavily on annuity sales and investment services will feel the greatest impact,” Morningstar reported in its Financial Services Observer prior to release of the DOL’s rules. The rules “will make it very difficult for many investment agents and professionals to continue offering investment services and retirement products to clients.”
Morningstar highlighted two reasons why it will be difficult. First, the new rules will look at insurance agents advising about the sale of annuities as fiduciaries, and thus needing not only to enter best interest contracts with their clients, but also to justify high-cost investment instruments to skeptical regulators. Even worse, they will have to justify those instruments to skeptical trial attorneys.
Rise of Robo-Advisers and Passive Investing
The new rules are expected to have mixed effects on full-service wealth managers, although the overall effects will tend toward the negative. For example, Morningstar said the sector will encounter negative effects from the shift toward fee-based accounts, which, while producing higher revenues per account, will cause as much as $600 billion of low-net-worth IRA assets to find new investment channels. Among the beneficiaries will be firms offering advice through robo-advisory systems.
The shift toward robo-advisers is seen pushing such firms toward the critical threshold of $16 billion to $40 billion in collective assets under management, which is believed as the level they need to attain profitability. The use of robo-advisers, meanwhile, is seen directing investors toward passive investment products. Discount brokers, too, are seen furthering the trend toward passive investing because of the DOL rules.
It has been apparent since the introduction of the DOL’s rules in April 2015 that it would cause some firms to lose. The Morningstar report helps describe who the losers are as well as indicate who will be among the winners.
