How will the Department of Labor’s fiduciary rule affect the defined contribution market when it is fully implemented at the start of 2018?

Two recently produced research reports set out to address that question.

Loren Fox, director of research at Ignites Research, a division of the Financial Times Co., says to date, much of the rule’s analysis has been directed to the IRA rollover market.

But the rule also has clear consequences for advisors to defined contribution plans, and the Defined Contribution Investment Only managers who build investment vehicles for plan participants and sponsors, said Fox, who co-authored Ignites’ Adapting DCIO Strategy for the Fiduciary Rule report.

Scheduled for full implementation by January 1, 2018, the fiduciary rule requires all advisors to defined contribution plans with less than $50 million in assets to serve as fiduciaries to their sponsor-clients.

Taking a proactive approach to fiduciary rule

Fox says a substantial portion of plan advisor specialists are taking a proactive approach to complying with the rule ahead of its implementation.

“Many are well into the process of meeting with sponsors and reviewing fund recommendations as a direct result of the rule,” said Fox.

Ignites’ report, which surveyed 251 plan advisor specialists with an average of $770 million in DC assets under management, shows that one-third of advisors already plan to make changes to the funds in their clients’ investment menus.

And 55 percent said they are very likely to review the mutual funds they use before the rule takes affect.

While the fiduciary rule does not require advisors to recommend the least expensive investment options in order to comply with the Best Interest Contract Exemption, or limit advisors to only recommending passively managed funds, Fox says it will ultimately make actively managed mutual funds harder to sell.

Of the surveyed advisors, which were gleaned from Financial Times’ annual top 401(k) advisor list, 91 percent already serve as 3(21) fiduciaries.

That means they already operate under the Employee Retirement Income Security Act’s prudence standard.

Under the DOL rule, their roles as fiduciaries will be further codified under the BIC Exemption.

“As fiduciaries, all advisors have to make prudent recommendations,” noted Fox. “Controlling for the risk in an investment they recommend is difficult to do. But controlling for cost is much more manageable.”

That reality is expected to accelerate fiduciary advisors’ recommendations of passively managed investments.

When asked what products they plan to make more use of, 26 percent of plan specialists said indexed equity funds, according to Ignites’ report.

And about a quarter said they will look to incorporate active management in balanced funds that blend indexed strategies, so as to lower the cost of incorporating active strategies.

“The sense we get from the report is that an unofficial cap on expense ratios will emerge over time,” said Fox.

The report also polled Defined Contribution Investment Only product managers, who have already been increasing their focus on the management fees behind their funds, says Fox.

That will only intensify in a post DOL-rule world, says Fox. Ignites’ report says that 59 percent of DCIO managers said an actively managed large cap equity fund that charges more than 100 basis points, or 1 percent of invested assets, will “raise red flags.”

“None of this means that active management is dead,” said Fox. “But it you’re going to charge Rolls Royce prices, you have to deliver something special.”

Both DCIO managers and advisors expect the fiduciary rule to spark the most growth in R6 fund shares, which don’t have sales loads, 12b-1 revenue-sharing fees, or administrative fees.

And both managers and advisors expect to see more institutional share classes with lower investment minimums, and more use of cheaper Collective Investment Trusts to deliver active strategies.

“Anything that looks like revenue sharing is going to come under greater scrutiny once the rule takes effect,” said Fox. On average, 17 percent of the surveyed advisors’ compensation came from 12b-1 fees.

'Everything is up in the air right now'

Ultimately, the fiduciary rule’s impact on the defined contribution market will vary by entity, says Chris Brown, the principal and founder of Sway Research, which recently published The State of the DCIO Distribution 2017: Maintaining a Growth Trajectory in an Uncertain Market, the study’s 10^th edition.

For DCIO managers, most say they are in a holding pattern relative to the changes to their products that will come from the DOL rule.

“Everything is up in the air for them right now,” said Brown.

DCIO firms are investing more in their sales forces and in-house staff, which shows they are committed to the space, he said.

“But for the most part they don’t know the full impact of what the rule will mean for products,” said Brown. “They are waiting to understand how their distribution partners—record keepers and plan advisors—respond to the rule.”

Sway’s report shows that the DC market’s increasing shift to passively managed funds is having a “corrosive effect” on DCIO sales, as plan advisors continue to increasingly recommend indexed funds in key asset classes, including target-date funds.

Sway’s report broke its analysis of plan advisors into two segments:

Specialist retirement consultancies that manage more than $1.1 billion in DC assets
Retirement advisors that focus on affluent individuals but also have a significant DC business

Four out of five of the specialists think DOL’s rule will result in growth for their practices. As 3(21) and 3(38) fiduciary specialists, they already operate under flat-fee pricing. “They see themselves as already being expert in the DOL rule,” said Brown.

But the retirement advisors working with wirehouses or broker-dealers report a much deeper concern with the rule, according to Sway’s report.

“That segment is clearly worried,” said Brown. Sway’s survey shows 62 percent expect higher costs to comply with the fiduciary rule, and ultimately, lower profit margins.

Half expect higher compliance costs will be passed on to sponsors and participants, and four in 10 said the rule will negatively impact their IRA rollover business.

And it is not as if 401(k)s represent a trivial part of their overall business. While they tend to service smaller plans—average plan size was $2 million—non-specialist advisors had an average of $70 million in total 401(k) assets, which accounted for 40 percent of their practices’ total revenue.

“They expect the rule will create more work, more liability, and lower their profitability,” said Brown. “Some are definitely weighing whether or not to drop their smallest plan sponsor clients.”

Instant Insights /

DOL fiduciary rule expected to sharpen scrutiny of DC plan fees

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