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My Head is Spinning – How Does This Make Any Sense?

Investment Management

On the eve of the enactment of the DOL Fiduciary rule, I find myself scratching my head at the reactions of some leading financial services firms. Several of the largest brokerage firms have begun responding to the DOL Fiduciary Rule in mind-boggling ways.

Some firms banned commissions in retirement accounts, and then some back-tracked. Others are changing compensation schemes to align with the rule. Many firms are revisiting the line-ups of investment products they make available to their advisors – potentially a good thing if their line-up is full of poor or expensive investment options that have no place in client portfolios. However, there is one event that stands out to me for the absurdity of it.

In a recent article in Financial Advisor IQ, Murray Coleman writes, “The impact of a higher fiduciary standard… is also sending ripples into the makeup of product platforms. Morgan Stanley, for example, is reportedly taking Vanguard off its distribution platform.”

Morgan Stanley’s justification for this move? According to a Wall Street Journal article: “Morgan Stanley, which has more than 15,000 brokers, said it is removing the Vanguard funds as part of a broader overhaul of its mutual fund offerings. Over the past several months, the firm has been cutting 25% of funds it deems less popular or underperforming, a process it kicked off to help it comply with the Labor Department’s fiduciary rule requiring brokers to act in the best interest of retirement savers.”

Not popular? Underperforming? That’s an interesting take on a firm that has seen more inflows over the last year than all other fund companies combined (over $200BN through 5/31/2017). At First Ascent we have a tremendous amount of respect for the Vanguard organization and many of their investment strategies. We’re not the only ones. According to Russel Kinnel at Morningstar, 94% of the Vanguard funds they review are “medalists.” Medalists are the funds that Morningstar thinks are likely to outperform their category peer groups and appropriate benchmarks on a risk-adjusted basis over market cycles of at least five years.

How can a firm actually make an argument with a straight face that due to their new fiduciary duty, they must limit their advisors’ access to some of the best investment products available?

Vanguard and many others suspect that the true motivation is actually related to money, and has nothing to do with fiduciary duty. It is an important point that “most of Vanguard’s competitors pay Morgan Stanley $250,000 to $850,000 annually in order to give their salespeople access to brokers at their offices, sales conferences and other company-sponsored venues.” Vanguard is fairly unique in making a business decision to refuse to pay fees like this.

So in response to a rule that is designed to compel advisors to put client interests first, Morgan Stanley is limiting their investment offerings by making sure that all of the funds an advisor has access to pay the same high fee? If that is not a conflict of interest, I don’t know what is.

At the end of the day, these are all costs borne by the end investor. No one else. It seems obvious that the only way a fund company can pay for those distribution rights is to charge the end investor more.

I believe a true fiduciary duty requires many things, and transparency and honesty are among the key components.

What a world we live in.