New Retirement Rules: Winners and Losers
April 9, 2016 by Ben Levison
Last week, the Labor Department issued a new set of rules mandating that stockbrokers, insurance agents, and financial advisors must choose investments with their clients’ best interests in mind.
Sounds like a no-brainer, right? It should be, and for registered investment advisors, who have long been held to a higher standard, it is. But brokers and insurance agents—along with other professionals you may loosely have referred to as “advisors”—had been beholden to a mere “suitability” standard.
This meant that as long as the investment products weren’t wildly inappropriate, brokers were free to sell clients whatever funds, annuities, private real estate investment trusts, or what have you that offered the broker the biggest commission. The new rules mandate that anyone helping to manage your 401(k), individual retirement account, or other retirement plan be held to the higher, “fiduciary” standard.
The change is a big deal. Now, your broker must truly be able to justify why a particular product is in your best interest—and not his. Often, that boils down to: “Is there a cheaper comparable product?”
The new rules, which won’t go into full effect until 2018, don’t go as far as a draft promulgated a year ago, leading Wall Street analysts to call them “better than feared” and “less radical”—for the industry, that is. Initially, the market appeared to agree, sending shares of brokerages and other companies that would have been hardest-hit soaring. Yet those gains were pared significantly almost immediately—signaling that maybe, just maybe, the new rules will do what they were intended to do: let investors keep more of their hard-earned retirement dollars.
The industry pushed back on first draft of the rules, arguing that they encouraged the use of low-fee index funds above all else, and restricted the assets that could go into retirement accounts—futures contracts, options, and private REITs, for instance, wouldn’t have been allowed. Objections also were raised about the rules’ treatment of commissions and the complex compliance requirements they entail.
The final version addresses those objections. The Labor Department, which has jurisdiction over retirement accounts, will still require the use of a form called the Best Interest Contract Exemption that discloses all fees, commissions, and conflicts of interest that an advisor or broker might have—but a firm’s educational materials won’t fall under the fiduciary standard. The rules also make it easier for advisors to recommend actively managed mutual funds—great news if you’re a fan of stock-picking, as we are at Barron’s.
Other changes are less defensible. Now there are no restricted assets—which means that if an advisor decides futures trading in your IRA is in your best interest, it’s allowed. Same goes for variable annuities, even though their tax-deferred status makes them an extremely poor choice for holding in a 401(k) or IRA.
THE INITIAL MARKET REACTION was puzzling. Waddell & Reed Financial (ticker: WDR) rose 8% in intraday trading on Wednesday, but finished the day up only 0.1% as investors realized that the new rules will do little to slow the flow of assets out of more expensive, and poorly performing, actively managed funds into exchange-traded funds. Insurer Lincoln National (LNC), the third-largest seller of variable annuities, rose 2.6% intraday, but finished the day up just 0.2%. Lincoln estimates that 30% of its annuity sales will be covered by the new rules, and that it can shift to fees rather than commissions, writes Cathy Seifert, of S&P Global Market Intelligence. She estimates that sales of variable annuities are likely to fall 10% across the industry in 2016. Ouch! Similarly,American Equity Investment Life Holding (AEL), one of the biggest sellers of indexed annuities, fell 15%, since the new rules hold purveyors of these products to a higher standard than those selling traditional fixed annuities.
LPL Financial Holdings (LPLA) shares rose as much as 13% on the day the rules were announced; the advisory firm generates 46% of its commission revenue from variable annuities, private REITs, and other products now allowed in retirement plans, according to Keefe, Bruyette & Woods. But selling them could be far less profitable than in the past, since LPL might have to adjust its commission-based business model. “The transition of the business model will still drive significant head winds in the next few years,” UBS analyst Brennan Hawken wrote in a note on Wednesday. “We would use strength as a selling opportunity.”
The companies that will benefit from the rules were already profiting from low fees even before the news—especially Charles Schwab (SCHW) and TD Ameritrade Holding(AMTD); they could continue to do well as more advisors shift to a fee-only business. ETF providers such as BlackRock (BLK) could also continue to gain market share due to their low-fee products.
