Top 5 Takeaways from the New DOL Rule

Glenn A. Dial | 05/19/2016
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Summary

Now that the Obama administration has imposed its final fiduciary rule, financial advisors must interpret and implement this regulation in all its complexity. Glenn Dial cuts to the chase with five key takeaways from the enormous 923-page document.

1. Know the definition of fiduciary

The US Department of Labor's (DOL) final fiduciary duty rule, which was published in April, vastly expands the definition of fiduciary. Now, anyone who advises or makes recommendations to retirement plans, plan participants or IRA owners is considered a fiduciary. Even those giving advice or recommendations on transaction-based accounts, as well as those advising on rollovers and distributions, are now considered fiduciaries. Previously, professionals advising retirement clients were required only to provide recommendations that would be "suitable," which is not necessarily synonymous with acting in the client's best interest, according to the DOL.

Anyone who advises retirement plans, plan participants or IRA owners is now a fiduciary

The final ruling, however, did exempt certain types of actions from being defined as fiduciaries. Those who provide investor education without any type of product offering are not considered fiduciaries. Also, brokers and traders who simply take orders from retirement-plan clients without providing any type of advice or recommendations are likewise exempted. However, there are still grey areas that look to cause considerable confusion. One is financial advisors with clients who have multiple accounts—both IRA and non-retirement. Would "best practices" compel advisors to extend the fiduciary duty to non-retirement accounts as well? It's not entirely clear. This could lead broker-dealers, in an effort to maintain a standard level of service, to treat all clients in a fiduciary manner.

2. Business models will get a makeover

The fiduciary-duty rule has the potential to upend financial advisory business models as many firms contend with rising costs and reduced compensation. Being in compliance with the new rule means greatly boosting record-keeping and disclosure efforts, which means incurring significantly more business costs. On the compensation side, it's too early to fully quantify the rule's effects, but third-party payments such as commissions, trail fees and revenue-sharing agreements are all subject to greater regulatory scrutiny.

Being in compliance involves vastly more record-keeping, which means significantly more business costs

Given the vast changes to incurred costs and compensation structures, it's no surprise that financial advisors believe fiduciary duty rule will negatively impact their business—almost 75%, according to a recent Fidelity Investments survey. This could prompt a significant number of advisors to exit the business altogether, as happened in the UK when similar regulations were imposed in 2013. The UK banned financial advisors from charging commissions and now it's a fee-based-only industry in Britain, which has fewer independent financial advisors now than it did before commissions were banned.

3. Disclosure requirements seem endless

The enormous disclosure requirements that appeared in an earlier draft of the fiduciary-duty rule were deemed unworkable by the financial-services industry, and the DOL was wise to take note. In the final rule, the disclosure requirements were somewhat streamlined while a few others were shelved altogether. This is not to say that the final disclosure requirements are simple, but they have been improved. For instance, the disclosure requiring that advisors provide a one-, five- and 10-year history of the fees associated with any proposed investment, as well as a projection of what the fees may be in the future, has been jettisoned. Such a requirement would have completely contradicted existing Securities and Exchange Commission regulations, which expressly prohibit such projections.

Overall, however, the final disclosure requirements are still more onerous than many in the industry anticipated. For instance, there are disclosures required at the point of client contact and with each transaction, as well as a requirement for substantially more website disclosures. The new disclosures must include statements that advisors will adhere to a "best interest" standard; a description of material conflicts of interest; any fees charged by the financial institution; and information about whether and how frequently the advisor will monitor the client's investments. All of this information is also required to be maintained on an advisor's company website, and must be reviewed and updated quarterly.

4. Winners and losers under the new rule

Designed to help and protect investors, the new DOL rule could actually have the opposite effect as a shrinking number of advisors go "up-market" to find wealthier clients and higher levels of compensation. Relatively small-balance accounts, arguably the people who need retirement advice the most, would become cost-prohibitive and likely would lose access to retirement advice. The clients who do remain, however, could end up paying more as advisors pass along the rising costs of compliance with the new rule.

Smaller investors, the people who need retirement advice the most, could become cost-prohibitive as clients

Discount brokerages, index funds and robo-advisors could find the new DOL rule is a competitive advantageCertain segments of the industry, however, will find the new DOL rule to be a competitive advantage. The overriding beneficiaries will be discount brokerages, index and exchange-traded-product providers, and robo-advisors. This shift is part of a trend that has been growing in recent years, and the industry can look for it to accelerate as the fiduciary-duty rule bites down on business as usual.

Discount brokerages, index funds and robo-advisors could find the new DOL rule is a competitive advantage

5. Final doesn't mean it's over

In my many discussions with ERISA attorneys, financial advisors and plan sponsors, virtually all agree that the 923-page DOL regulation is incredibly complex and subject to various interpretations. The final fiduciary rule is being closely parsed by the financial-services industry, of which major segments could sue to block the rule from taking effect. Already, the American Council of Life Insurers, an industry trade group, has retained a law firm and is gathering evidence in advance of an expected court battle.

As this complex rule is phased in over the next year, we expect to see additional guidance from the DOL as well as some answers to the substantial uncertainty that still surrounds the rule. But as lawsuits gather and the industry finds certain aspects untenable, unacceptable and downright unworkable, we will likely see that the DOL's final fiduciary rule is anything but.

About Dialed In to Retirement
Dialed In to Retirement offers thoughtful insights from our US head of retirement strategy on ways to improve outcomes for plan participants, including analysis of emerging retirement trends, portfolio construction ideas, regulatory developments and behavioral finance research.


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Expert-Image

Glenn A. Dial

Managing Director, Head of Retirement Strategy
New York, New York
Mr. Dial is a managing director with Allianz Global Investors, which he joined in 2011. As Head of Retirement Strategy, he is responsible for overseeing the firm’s strategic planning for the US defined contribution channel. He previously held senior-management positions with JPMorgan, Merrill Lynch and Ceridian. Mr. Dial is a co-inventor of the method and system for evaluating target-date funds, and is also credited with developing the target-date fund-category system commonly referred to as “to vs. through.” Mr. Dial has a B.S./B.A. in finance from the University of Central Florida and an M.B.A. from Rollins College.

Has Investment Diversification Alone Had Its Day?

Glenn A. Dial | 08/05/2016
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Summary

The idea that investment diversification can enhance returns and lower risk hasn't played out as planned in post-crisis markets. This may come as a surprise to retirement investors, who should now consider a more dynamic approach according to Glenn Dial.

Modern portfolio theory as relic of the past

In 1952, economist Harry Markowitz published his seminal work on modern portfolio theory (MPT), which showed that investors could increase their return potential and simultaneously lower their risk profile by investing in a diversified range of assets. MPT revolutionized the way that investors invest, especially retirement investors, many of whom built their retirement savings on the tenets of diversification over the course of decades.

MPT has become so prevalent and well known that it seems to have moved past being a theory and into being an actual fact. But like so many other ideas that got swept up and exposed during the financial crisis, MPT hasn't fared as well in the post-crisis world. Asset classes once thought to be complementary showed remarkable correlation as bonds, stocks, emerging markets and even many alternatives became all bunched-up on the efficient frontier. And as the recovery from the financial crisis continues apace, investment assets continue to show much closer correlations than in the past.

RiskMonitor measures the hazards of 2016

Close correlations among asset classes were most recently evident in the aftermath of the Brexit vote—an event risk—when global markets plunged in unison and caused many investors to question their diversification strategies yet again. Add to that a recent string of deadly terrorist incidents, ongoing geopolitical concerns, and a US presidential campaign unlike any other in history. All-in-all, event risk looks to be an ever-present concern for the remainder of 2016.

This is the thinking of many institutional investors as shown in the recently released AllianzGI RiskMonitor 2016, a worldwide survey of 755 institutional investors, including some of the world's foremost pension funds, banks and sovereign wealth funds. When asked what the biggest risk is for 2016, 75% of our respondents named event risk, which is the possibility that an unforeseen event will negatively impact a country, company or industry. This is up significantly from last year's survey, which showed event risk ranked at the very bottom of institutional investor concerns.

The 2016 RiskMonitor also shows that diversification, despite its shortcomings in recent years, still ranks as the No. 1 way for investors to combat volatility. This is above other well-known risk management techniques such as increased allocations to fixed income or defensive equity. It's a good bet that if the RiskMonitor survey included financial advisors and plan sponsors, their answers would be remarkably similar, showing once again that risk doesn't discriminate.

For a look a closer look into how diversification has failed to live up to its promise, consider two particularly volatile months in global markets as shown below. October 2008 was the height of the financial crisis, leading to steep declines across most asset classes. It's been estimated that 401(k) and IRA investors lost approximately $2.4 trillion in aggregate value during the final two quarters of 2008. Fast forward to August 2015—while not as dire as the financial crisis, the month nonetheless featured pronounced fears of a China economic slowdown and worsening Greek debt woes. And just like in October 2008, most asset classes fell in unison and showed the shortcomings of diversification.

The Limits of Diversification: It fails when you need it most

October 2008

Limits Chart October

US Equities Large Cap Int'l Equities US Gov't Bonds US Corporate Bonds US Equities Small Cap EM Equities US High Yield



August 2015

Limits Chart August

US Equities Large Cap Int'l Equities US Gov't Bonds US Corporate Bonds US Equities Small Cap EM Equities US High Yield



Source: Bloomberg. Past performance is not a reliable indicator of future results. US Equities Large Cap are represented by the S&P 500 Total Return Index, International Equities are represented by MSCI Daily TR Gross World Ex US Index, US Government Bonds are represented by J.P. Morgan GBI US Unhedged LOC Index, Corporate Bonds are represented by BofA Merrill Lynch Corporate US Bond Index, US Equities Small Cap are represented by the Russell 2000 Index, Emerging Market Equities are represented by MSCI Daily TR Gross EM USD Index, US REITs are represented by FTSE E/N All Equity REIT TR Index, Commodities are represented by Bloomberg TR Index, Emerging Market Debt is represented by MSCI Daily TR Gross EM USD Index, US High Yield is represented by the iBoxx USD Liquid High Yield Index.

A dynamic approach can deliver

The 2016 RiskMonitor also points to missed opportunities with potentially devastating consequences. Eight years out from the financial crisis, our survey shows that risk management practices have changed very little. This comes despite nearly half of our respondents admitting their current risk strategies provided too little downside protection, while almost 60% would sacrifice upside potential for added protection against volatility.

One of the biggest changes the 2016 RiskMonitor found in terms of pre- and post-crisis risk management is institutional investor use of dynamic asset allocation strategies, which increased from approximately 40% pre-crisis to 50% post. Institutional investors are coming to realize that a dynamic approach can exploit the cyclicality of asset-class returns and achieve a meaningful, positive impact on a portfolio's risk/return profile.

The big idea behind a dynamic approach is that asset classes exhibit both "trending" and "mean-reverting" return patterns, the cyclicality of which can be captured by a sophisticated combination of trend-following and mean-reverting allocation responses. By combining them, the resulting allocation seeks to balance "as many return-seeking assets as possible" with "as many safe assets as necessary."

At the core is a rules-based, repeatable process that can "up-risk" or "de-risk" according to changing market conditions. The dynamic process also drives decisions about when to take profits and when to re-enter markets. If the rules are effective, and a dynamic risk-mitigation strategy is successfully implemented, an investor can participate more fully in rising markets and preserve capital to a greater degree in declining ones. And in the current low-growth, low-rate environment in which retirement investors must contend, a dynamic approach could make all the difference in ensuring a rewarding retirement.

About Dialed In to Retirement
Dialed In to Retirement offers thoughtful insights from our US head of retirement strategy on ways to improve outcomes for plan participants, including analysis of emerging retirement trends, portfolio construction ideas, regulatory developments and behavioral finance research.


105007

Expert-Image

Glenn A. Dial

Managing Director, Head of Retirement Strategy
New York, New York
Mr. Dial is a managing director with Allianz Global Investors, which he joined in 2011. As Head of Retirement Strategy, he is responsible for overseeing the firm’s strategic planning for the US defined contribution channel. He previously held senior-management positions with JPMorgan, Merrill Lynch and Ceridian. Mr. Dial is a co-inventor of the method and system for evaluating target-date funds, and is also credited with developing the target-date fund-category system commonly referred to as “to vs. through.” Mr. Dial has a B.S./B.A. in finance from the University of Central Florida and an M.B.A. from Rollins College.
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