In a new report released last week, Morningstar says the Department of Labor’s fiduciary rule could have a drastic impact on the profits and business models of the asset management and brokerage industries. Michael Wong, equity analyst, capital markets, and lead author of the report, argues that the rule could lead to a decrease in the number of advisors in the U.S., similar to what happened in the United Kingdom with its Retail Distribution Review. WealthManagement.com spoke with Wong about this potential impact as well as others, such as a reduction in commission-based accounts, a cut in advisors’ pay, and the account consolidation opportunity.
WealthManagement.com: Could the effects of the DOL rule here be similar to those in the United Kingdom, with its Retail Distribution Review?
Michael Wong: Our summary assessment of what happened in the United Kingdom was that there was a decrease in the number of financial advisors, an increase in passive and a higher usage of fund platforms. At a company-specific level, there was an increase in explicit advice charging. That generally didn’t completely offset the loss in commissions and trail fees. Many of those industry and company-specific level effects that occurred in the United Kingdom have a high likelihood of also occurring in the U.S.
If a financial advisor is no longer receiving a 25 basis point trail fee, which really is, to an extent, a fee for the continuing financial advice on that product, in order for them to stay in the same economic position, they may just go ahead and charge an upfront 25 basis points financial planning fee. There’s an entire value chain affected by the Department of Labor rule. You have the product manufacturers, such as the asset managers and the insurance companies. Then you have the wealth management firm level; then you have the individual financial advisor level. Then you have the individual investor level. At any stage in that value chain, there could be a potential shift in the economics.
WealthManagement.com: Do you think this could cause a decrease in the number of financial advisors as it did in the U.K.?
MW: The extent would be difficult to quantify, but it’s hard to imagine this would be positive for the number of financial advisors. Definitely the compensation or the revenue line of the financial advisors will be affected by this rule, so the top line will be affected. The increase in compliance costs means that the bottom line of financial advisors will be affected. So if you have potential compression in the top line and compression in the bottom line because expenses are creeping up, that means it will be less economically viable for financial advisors. When that happens, they’re going to have a certain amount of financial advisors exit.
WealthManagement.com: Do you think this DOL rule could be the end of commissions?
MW: There is a very distinct and definite possibility that there will be a reduction in commission-based accounts available to clients that want financial advice. For one thing, the Department of Labor rule only affects retirement accounts. So definitely this isn’t the end of all commission-based brokerage. That said, if you have a financial advisor that deals with both taxable accounts and retirement accounts, they will have to deal with balancing act of dealing with a separate rule set possibly across clients and with the exact same client. So if any client has a retirement account with them, whether they want to move that client entirely to a fee-based arrangement, we’ll have to see.
WealthManagement.com: Is there a data point that advisors should take away from the report?
MW: It’s probably our low-end estimate of prohibited, front-end loads for mutual funds and 12b1 fees of $2.4 billion for the industry. So many of those financial industry reports and government reports have focused solely on the costs of implementation. That said, unless the individual financial advisor is an independent advisor that runs their own business and is the bearer of the costs, most financial advisors, like employee advisors, will not actually see those costs. That said, any financial advisor who is receiving trail fees from mutual funds or annuities or is receiving commissions from insurance products or mutual funds may see a cut in their paycheck based on this DOL rule.
WealthManagement.com: Who do you expect will be the biggest beneficiaries of the rule?
MW: The overriding beneficiaries will be the discount brokerages, the index and exchange traded product providers, and robo-advisors. Something that we didn’t put in the report could very well be registered investment advisors that are already under a fiduciary standard.
Certain wealth management firms are also competitively advantaged. We laid out the account consolidation opportunity. Let’s say a full service wealth manager used to have a minimum of $50,000, and then after this rule is passed, they decide they really need a minimum of $100,000 in order to make that client relationship viable. If they truly become the primary wealth manager of that client, that client may start to consolidate assets with that financial advisor. Maybe they’ll move deposits out of their regular bank account in order to meet that $100,000 minimum that’s increased from $50,000. Maybe they use two financial advisors, and then will consolidate their accounts with one financial advisor. Maybe they had a relationship with a discount brokerage and a full-service wealth manager and decide to pull money out of that discount brokerage and give it to that full-service wealth manager.