Post-Conflict of Interest Rule to Focus on Risk Over Return

New research from global analytics firm Cerulli Associates indicates that compliance with the new rule is the number one priority of managed account sponsors.

The Department of Labor (DOL)’s Conflict of Interest rule main purpose is to help plan participants and Individual Retirement Account (IRA) holders, who often lack investment knowledge, receive expert advice in their best interest. This puts managed account sponsors in a position to educate advisers on everything that could be considered a conflict of interest, as well as changes to documentation procedures and technological systems, says global research firm Cerulli Associates.

According to lawmakers, conflicts relating to financial advice cost Americans approximately $17 billion every year. To limit risk, advisers may seek to reduce the number of products available, Cerulli reports.

“With the implementation of the new rule, sponsors will embrace a portfolio construction philosophy that seeks to reduce risk, lower fees, and use passive investment vehicles,” says Tom O’Shea, associate director at Cerulli.

O’Shea adds “Advisors report that by 2018, 58% of ETFs they use in client portfolios will be pure passive vehicles, while 21% will be active ETFs and 20% will be strategic beta ETFs. Home offices’ desire to mitigate risk presents an opportunity for actively managed funds.”

Eventually, Cerulli notes, plan sponsors may want advisers to turn over portfolios to the home office. The firm’s data indicate that home-office model portfolios often outperform adviser-driven portfolios, and pose less of a compliance risk.

While Cerulli notes that home-office personnel may find advisers resisting the risk controls placed on their accounts by parent firms, their research suggests that “very few advisers understand the risk embedded in the portfolios they create for clients.”

Cerulli cites a senior executive at a major asset manager in saying that “In some 60/40 portfolios, up to 90% of the risk is equity volatility.”

O’Shea says, “We expect asset managers to see a greater demand for passive ETFs in managed accounts, which will result in clients owning very similar, cookie-cutter portfolios. In order to set themselves apart, financial consultants will have to focus on other higher order investment advisory activities, especially goal-based planning.”