Investment Industry Must Double Down on Fairness and Transparency

In the retirement planning and investment industry of the near- and long-term future, providers’ motivations will play a deep role in determining success.

The investing industry and its professionals need to move from a performance-driven culture to one that is more purpose-driven to better ensure clients’ long-term goals are met.  

That’s the consensus of a handful of retirement industry professionals interviewed recently by PLANADVISER and/or cited in newly published research: Wanting to do the right thing is slowly but very surely becoming a prerequisite for business success under the Employee Retirement Income Security Act (ERISA).

According to the CFA Institute and the State Street Center for Applied Research, which recently released a joint study on the topic, “Motivation as the Hidden Variable of Performance,” short-term thinking has woefully disconnected some providers from their “shared purpose of achieving clients’ long-term goals and in turn contributing to economic growth.”

This will probably be a familiar charge for defined contribution (DC) industry advisers, who have seen their motivations questioned harshly by Department of Labor (DOL), other regulators and, increasingly,the plaintiffs’ bar.  

Amid this environment, organizations that are able to “go back to basics and rediscover their purpose … should be able to perform better in any return environment.”

“We need to embed in our habits and incentives the connection to purpose,” the report argues. “As in quantum mechanics, where a ‘hidden variable’ is an element missing from a model that leaves the system incomplete, we find the same situation in investment management … There seems to be an intangible factor that has not previously been quantified.”

The researchers call this variable “phi,” but it could just as easily be called “the will to do the right thing.” Researchers suggest “phi” can actually be quantitatively derived from the “motivational forces of purpose, habits and incentives that govern our behaviors and actions.” The phi motivation is distinctly different from the short-term outperformance motivation or asset gathering focus of our industry, researchers explain.

“The results of our analysis were exceptional: A one point increase in ‘phi’ is associated with 28% greater odds of excellent organizational performance, 55% greater odds of excellent client satisfaction and 57% greater odds of excellent employee engagement,” the report concludes.

Further, according to State Street and the CFA institute, research based on “Self Determination Theory” has found the best work climates generate the additional skills the investment industry needs to fully realize individual performance potential.

“Cognitive flexibility, creativity, ownership and citizenship. In the context of finance, these sound rather esoteric, but given the disruptions occurring in today’s environment, this is precisely the time when these new skills will separate the winners from the losers,” the report concludes.

NEXT: Fiduciary reform portends deeper changes 

John Resnick, vice president in charge of adviser development for Efficient Advisors, urges his industry colleagues to think deeply about the Department of Labor fiduciary rule—suggesting the regulation is perhaps only a bellwether for what is to come.

“In the retirement planning and advice industry of the future, it is not enough to just say you are being loyal and prudent—you have to be able to provide evidence that you are prudent and loyal,” Resnick warns. “The DOL has gone into great detail defining what conflicts and prohibited transaction look like in today’s marketplace, as well as how to avoid them, so there really is no excuse that clients are going to want to hear.”

Even in the case that the DOL fiduciary rule implementation is halted by a Trump administration and Republican Congress before the first deadlines pass in April 2017, Resnick suggests many firms will continue to charge ahead on instituting their own conflict of interest reforms. “Many in the DC and IRA space have already laid out their reforms, moving to offer less variable commission-based business in favor of flat fee advisory arrangements already desired by many clients,” he notes. “We have always embraced the fiduciary standard, and so it won’t be a surprise to hear us predict that this pathway will offer a strong competitive advantage for firms moving down this path.

“If you haven’t thought about the challenges of continuing with variable commission-based business and made the necessary internal transitions, it is high time to be doing so,” Resnick adds. “If you want to stay in this business, that’s going to be the price of admission. Even if a Trump presidency pauses or halts the rule—clients will begin more and more to demand this.”

When it comes to actually structuring products and business practices for the future, Resnick says it doesn’t have to be rocket science.

“In the future we are all going to be moving further and further away from a commission-based and product-based view of the world in favor of a relationship and advice-based view,” he predicts. “It’s a fiduciary fortified model. The key notion is that the recommendation is the cornerstone of the relationship and the crucial area where conflict can exist, at least from the perspective of the DC adviser.”

Resnick goes on to suggest it is “extraordinary” how many assets, especially on the IRA side, are still tied up in commission-based accounts: “It’s $4 trillion, literally, so there is so much opportunity to rescue folks from this product-driven and commission-based, conflicted environment, into a fiduciary fortified and level-fee, transparent approach.”

NEXT: Plan sponsors and participants clearly need new support    

Reflecting on these points, Rob Austin, director of Retirement Research at Aon Hewitt, observes that there is still a lot of uncertainty in terms of how exactly the advisory industry and the motivations of its professionals will have to evolve in the years and decades ahead.

“There has been real momentum building behind the rule since 2010 or earlier, and that will be hard to stop, even for an aggressive Trump administration,” Austin observes. “And at the same time, clients are becoming a little more in tune with the fiduciary language, so we will have to see whether that momentum is enough to carry the fiduciary rule through.”

A lot of advisers and providers speaking with Aon Hewitt still want to see the rule come down and for the strict new conflict of interest standards to be enforced, Austin adds.

“I talk to a lot of people across the industry and this remains such a hot topic, but it is very difficult to make broad statements about what advisers’ and providers’ motivations should be given all the uncertainty,” he says. “There is something to say for wanting to do the right thing and using that as your guidepost, regardless of what’s happening around you in the industry. Perhaps that’s a little idealistic, but, given all the long-term trends around fee fairness and transparency—it may be best to just keep pushing ahead and aligning yourself with a non-conflicted business model that can hopefully thrive regardless of the current regulatory environment.”

Austin concludes that “one thing that we all know about government and business leaders—in general they’re very aware of the politics and the optics of their decisions.”

“Do they want to be viewed as coming out and opposing a rule that, according to the regulators, is meant to protect the little guy?” Austin asks. “It is doubtful. Companies would not want to be in the position of having their loyalty to clients questioned. So in this sense, perhaps idealism is going to be the way forward, whether the final fiduciary rule takes effect in April or not.”