I was somewhat pleased to see this article on Bloomberg over the weekend. In brief, among the proposals hitting our new US Congress is a new requirement for financial brokers (think – the guy from the big bank with a sharp suit, managing your retirement funds for around 1% per year plus some commissions) to adhere to fiduciary duty over client assets. This is a pretty big deal, which leads to much lobbying.
Where’s the beef? Under current laws, and what amazed me when I took the required exams, financial brokers must ensure that clients’ portfolios only include suitable investments. Suitable is really in the eye of the broker – he/she can decide, and justify accordingly.
For example, consider a financial broker managing the retirement funds of a well-paid physician:
- The broker could choose a structured product, generally mirroring the S&P 500, with lots of bells and whistles and fees associated.
- The product is suitable, as it achieves exposure to economic growth
- The bells and whistles might also be suitable, if the broker believes the physician wouldn’t like the risk of a big drawdown (say).
- What is missed is the fees – the broker would very likely be paid well to sell this product; the fees might or might not be disclosed to the investor.
- Under fiduciary duty, the broker must consider the client’s needs first. In this case, the physician’s situation (well-paid, likely high risk tolerance) means the bells and whistles aren’t necessary, and the extra fees are a bad thing. So this structured product would need to be rejected in favour of, say, a low-fee ETF.
When is fiduciary duty a bad thing?
- The article outlines the main issue from financial brokers – basically the line of reasoning that physicians have in the US. The duty imposed will lead to much more cautious behaviour by the broker, as well as much more defensive paperwork to ensure compliance. Of course that will mean higher fees. I don’t believe this for a second, unless ‘defensive’ means ‘seeking lower fee products’.
- In my opinion, the main drawback of fiduciary duty is the over reliance on lower fees = better. That can lead some advisors to completely ignore higher-cost, but diversifying offerings (e.g. alternative investments). In the quest for lower fees, opportunities can be lost. The broker (earning commissions) will more likely seek out – or be sought by – managers who provide something different for the portfolio. Basically, if the advisor believes he/she is constrained by fiduciary duty to stick with long-only equity and bond ETFs, he/she is missing a wide world of investment opportunity.
In sum: the fiduciary duty standard better aligns the interests of the investment broker with the client. For those of you using investment brokers or advisors, you might ask whether they adhere to this standard already – for example, the usual case with fee-only financial advisors (i.e. no commissions) is to adhere to this standard by default. If I used an investment advisor, I’d demand the fiduciary duty standard…but would frequently ask the question “so what is new in the investment world, in terms of markets?” and be interested to hear the answer. If you’re being paid to manage money, you should be up to scratch in a wide world of investment opportunities.