The DOL Fiduciary Rule still remains uncertain although part of the regulation went into effect earlier this month. Most of the debate about the DOL Fiduciary Rule is ridiculous. Who would be against a common sense rule that requires advisors put client interests first? Any advisor not doing this shouldn't be an advisor to begin with. From a client point of view, it is non-sensical to argue against the DOL Fiduciary Rule. Who wants an advisor putting commissions above the client? Would a doctor remain in business if he did not put his patients' interests above his own? The truth about the DOL fiduciary rule: it's long overdue and it should do more to protect investors. It only covers retirement accounts of individuals, not taxable or institutional accounts, and it should do more to protect investors from fees.
John C. Bogle, founder of both The Vanguard Group and the first index mutual fund, wrote on this topic in the Financial Analyst Journal. The article, titled "Balancing Professional Values and Business Values", can be accessed here. The article is written for financial professionals, but I think it is a valuable read for clients as well. It is tough to come up an argument against his points.
The argument against the DOL Fiduciary Rule is the required record keeping. Since client account records and information are already collected and stored by advisors, this argument doesn't hold much water. A more interesting question is how did we get to the current status quote of selling products to generate commissions rather than putting clients first? Why is anyone (accept brokers themselves) defending a commission-based relationship? A transaction based model has never been in the clients best interest, yet much of the financial advisory industry still works on commission. There seems to be a growing shift toward a percentage fee on AUM model which is a step in the right direction. The short answer to how we got here is 'profits'. Brokers make more money from transactions then from fees on AUM, and that is a real shame on the industry. Now the industry has to move away from the commission-based distribution model. This may hurt broker profits in the short-term, but it is clearly in the best interest of clients. The DOL Fiduciary Rule is long overdue and more is needed to straighten out the unnecessary conflicts built into the current advisor/client relationship. For example, 12b-1 fees are sales fees which some mutual funds pay to advisors who sell those funds to clients. Clients may not even be aware of these fees which they are paying to their advisor because they are buried in the mutual fund expense ratio. These 12b-1 fees should be done away with as well as mutual fund loads. Both are fees investors should not pay... it's just common sense.
In 2015, Geoff Colvin, Senior Editor at Large with Fortune Magazine, published Humans Are Underrated: What High Achievers Know That Brilliant Machines Never Will. The book describes a new economy and the displacement of human jobs by computer software. The most interesting parts of the book were about what skills will be highly valued in the future economy. Colvin emphasizes the human-to-human interactions of empathy, story-telling, and team-building as examples of skills not likely to be automated. Why are schools so focused on teaching kids STEM, science technology engineering and math, not empathy, story-telling, and team-building? The transition from the knowledge-based economy to the human-connections economy will allow workers to focus on human interactions and relationship building. The book is an interesting read, but the sweeping conclusions are a bit idealistic and utopian. When I first read it, I wanted to run out and become a therapist. I can empathize, I thought. But future jobs will likely require both knowledge in STEM and skills in human interaction. It's not one or the other, but rather a need for both. Colvin makes it sounds like empathy, story-telling, and team-building will get you the next fortune 500 CEO job. It's a combination of knowledge-skills and soft-skills. The engineer who can empathize and the lawyer who is a story-teller. Of course, we all want a doctor with a good bedside manner, that's not a new idea. Colvin concludes healing and diagnostic skills will be automated, and the only thing the doctor will be left to do is feel for you, but I think this is an over-simplification. He touches upon team-building and the value of colocation, and highlights the fact that women typically score higher in the soft-skills area. Colvin brings all these human qualities together to underscore the importance of human connections. The broad conclusion on how the economy will function in the future is a bit of a stretch in my opinion. But his argument is completely compelling. Are empathy, story-telling and team-building important? Yes, for sure, but is social worker pay going to jump above software engineer pay anytime soon? I doubt it. It's a thought-provoking, well-written book and worth a read.
You can read a review by Tyler Cowen at the Washington Post here. A short adaptation of the novel is printed here.
Martijn Cremers is a Professor of Finance at the Mendoza College of Business of the University of Notre Dame. He published a research article in the latest Financial Analysts Journal titled, "Active Share and the Three Pillars of Active Management: Skill, Conviction, and Opportunity." The paper, accessible here and here, includes some great research on Active Share, Active Fee, holding period, and market cap. I recommend it to anyone interested in academic research on investment management. Active Share was first introduced by Cremers and Petajisto (2009) as a percentage of a fund's portfolio that is different from the fund's benchmark. One of the primary conclusions of Cremers' research is active managers with low Active Share tend to consistently underperform.
Cremers did NOT found statistically significant evidence that high Active Share led to outperformance or underperformance (although it may be a good starting point in fund selection). He did find strong evidence that low Active Share led to underperformance. These active managers are sometimes called closet indexers because they charge an active management fee for an index-like portfolio. To boil it down, if you are going to invest with an active manager, look for an Active Share north of 70% or even 80%. Cremers also provides Active Share information on mutual funds free of charge via the website activeshare.info. If you would like help looking into this or more information, please contact me.
Michael Grove, CFA