Not since the run up to passage of the Pension Protection Act (PPA) or, thinking further back, the creation of the Employee Retirement Income Security Act (ERISA) have retirement plan advisers faced so much regulatory disruption.
The coming year promises to bring fundamental fiduciary reform, for starters, observes Shelby George, senior vice president for adviser services at Manning & Napier. Add to this the federal government’s stated interest in creating more state-based retirement plans for the private sector and various other reforms coming down the pike, such as the Securities and Exchange Commission’s (SEC) liquidity and money market fund reforms and key Affordable Care Act (ACA) deadlines—think Cadillac Tax—and it can make a benefit plan adviser’s head spin.
“Being an ERISA plan fiduciary is not easy and it is only going to become more challenging,” George told PLANADVISER while discussing the firm’s newest research paper, “Understanding how today’s challenging regulatory landscape impacts your practice and clients.” She predicts more advisers will be lumped into the fiduciary relationship in 2016 and beyond, suggesting the Department of Labor (DOL), through its updated fiduciary rule, “will extend the fiduciary standard embedded in ERISA to advisers who handle any kind of retirement account, including individual retirement accounts (IRAs).”
Noting that the fiduciary rule language has been submitted to the Office of Management and Budget and is “finally about to arrive,” George predicts the best-interest contract exemption and other key aspects of the proposed rule language will be maintained in any final rule. Advisers and providers will complain when the rule language finally emerges, she adds, “but they will very quickly have to get to work assessing the new layer of administration they’ll have to build out to meet all the new requirements.”
The final aspects of the fiduciary standard will be shrouded in some mystery until the final rule language actually emerges from OMB, George explains, but she still predicts pretty confidently that the biggest impact is going to be on the IRA market and rollover accounts. Unless major changes are made to the rule language, advisers selling in these areas will have to start papering best-interest contract exemptions left and right.
NEXT: Regulation is just one challenge
Beyond the difficult regulatory picture that is testing advisers, George says the interest rate environment and related fixed-income investing outlook is another challenge.
“Over the past 30 years, interest rates have declined very slowly and steadily,” she explains. “Today, the interest rate outlook is challenging. The Federal Reserve is trying to raise rates while yields are still at very low absolute levels, and therefore rates have more room to go up than down. However, an increasingly interconnected world means events from around the globe can influence U.S. growth and ultimately the direction of interest rate movements.”
Investors of all types—including their advisers—have generally grown unfamiliar with how interest rate movements affect traditionally “safe” bond investments, George warns. “Related, using a bond index fund to gain exposure to the broad fixed income market has become a common investor strategy and has been considered a safe strategy,” she says. Today that picture is falling apart.
“The key point to realize in a fluctuating interest rate environment is that bond portfolios tied to a benchmark may not deliver the best the market has to offer,” George explains. “Typically, a benchmark’s composition is market-capitalization weighted according to the total value of debt outstanding in the market; it’s not based on the fundamental characteristics of each bond.”
George predicts even savvy investors may need assistance from their advisers in understanding how a portfolio can be expected to perform in different environments. “Fiduciaries responsible for retirement plan assets need to understand how interest rate movements may affect plan participants who are nearing retirement and are more exposed to this traditionally ‘safe’ asset class,” she adds.
All in all, George says that “bond market volatility has become a heightened source of risk for those investors nearing the date that they will need to start living off their savings.” This results from the higher allocation to fixed income near retirement, which may mean being more heavily exposed to the most overvalued sectors of the bond market, like U.S. Treasuries, at the same time that stability of retirement balances becomes most important to meet ongoing living expenses.
“The answer is not to simply own more stocks when nearing retirement, since volatility is inevitable in the stock market,” she concludes. “Active, flexible management of fixed income portfolios with the ability to adjust maturities and sector exposures to avoid taking risk, unless well-compensated for those risks in the form of more attractive yields, is most important for investors right now.”