“It’s a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first.” – President Barack Obama, February 23, 2015
From time to time my avid reader base suggests the topic for one of my blog posts. My good friend Ted, drew my attention last week to the new US Department of labour regulation that requires anyone providing advice on retirement investing to “act in the interests of the client”. Apparently, after many years of resistance, retirement advisors will formally bear a fiduciary duty to their clients. My initial reaction to the news was “… Since when has there not been a fiduciary duty of an adviser to their clients?”
Financial advice is a grubby exercise. Markets, by their nature, are risky animals and there is no guarantee that even the best conceived financial plan makes money over the short term, medium term or long term. There are broad financial principles that need to be considered, but there is no single “right way” to invest money. To my mind, the broad financial principle’s that an advisor should follow are (i) take risks that earn a risk premium (ii) diversify (iii) limit turnover and transaction costs. On the face of it, these three principles argue for passive index funds. But there is evidence that smart-beta and some active managers (who deliberately invest in undiversified portfolios AND generate turnover and transaction costs), can outperform published benchmarks. If the academic world has yet to unanimously endorse a single “right way” to invest, where does that leave the advisors?
So, while it is admirable that the Department of Labor has recognised the fiduciary relationship, they fall short by not providing practical guidance as to what constitutes acceptable advice and what is not. Leaving it to the Courts to determine is a cop out, since some contingency law firm will launch a class action with a group of orphans/widows who lost money from ‘bad advice’ and that will set off a chain of litigation that utlimately leads to no answer.
The Industry Fund phenomena in Australia may well provide the role model to answer the question as to what constitutes acceptable advice. The genesis of these funds came from the union movement who wanted to provide a cost effective means for their members to invest their retirement savings. These funds are now massive ($100billion+ in some cases) but their objectives remain the same – affordable, professionally managed vehicles for small investors’ retirement savings. The directors of the funds seem genuinely interested in their member’s future well being. In practice, these funds run a mix of active and passive strategies, operating within a broad average fee cap for the funds.
Perhaps the Department of Labor can be pro-active in identifying an acceptable model to achieve Obama’s fiduciary objective?