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S&P Capital IQ


09/22/16 05:00:47 PM


Advisors and investors should expect changes to the fund universe ahead of and following implementation of the Department of Labor's Conflict of Interest Rule (the Rule). This is one of the takeaways from the September 2016 S&P Global Market Intelligence survey of its asset management and financial advisory client base.

The Rule, announced in April 2016 and to be initially implemented in April 2017, requires all who provide retirement investment advice to abide by a fiduciary standard by putting their clients' best interest before their own profit.

The changing requirement for advisors is coinciding with increased adoption by investors of lower-cost equity exchange traded funds. Year to date through September 7, equity ETFs had $63.6 billion of net inflows, while comparable equity mutual funds had $144.1 billion of net outflows.

Someof the asset management respondents to the S&P Global Market Intelligence survey responded that they expect their firm's operating model would change as a result of the Rule. The most frequently chosen answer given was "changes in expense ratios for existing funds" followed by "creation of new products" and "increased focus on passive or index-based products".

Actively managed funds charge a premium for their efforts to outperform a benchmark, even though the majority of the survey respondents think that passive funds provide comparable returns to active investing.

The average expense ratio for an actively managed Lipper large-cap core mutual fund was 110 basis points (1.1%), significantly higher than the 5 basis points for Vanguard 500 Index ETF (VOO 196 Overweight). The mutual fund peer group has incurred $36.2 billion of net outflows year to date through August, while VOO gathered $7.7 billion of new money.

Asset managers will need to be cognizant that advisors will be questioning whether their clients' best interest is being served by active funds that are more expensive than their peers.

The large-cap core share classes with the highest expense ratios and with more than $1 billion in assets under management include Clearbridge Value Trust (LMVTX 66 ***), Davis New York Venture (NYVCX 28 ***) and American Funds Fundamental Investors (AFICX 53 ****). Advisors that hold the C class products in client portfolios get paid an annual fee, which might not be viewed as putting clients' best interest before their own profit.

For instance, Clearbridge, a subsidiary of Legg Mason (LM 33 **) has suffered significant declines in its assets under management, according to S&P Global Market Intelligence Equity Analyst Erik Oja, who cites those declines as one of the reasons for his sell recommendation on the parent company.

Meanwhile, more than half of the financial advisory respondents said the majority of active funds they selected did not outperform benchmarks over the last three years. This is consistent with the S&P Dow Jones Index Versus Active 2015 year end study, which noted that just 19% of all domestic equity funds outperformed the S&P Composite 1500 index.

The increased focus on passive or index-based products answer given by the survey's asset management respondents is also consistent with the industry's efforts in the past year. Earlier this month, Fidelity announced plans to launch six smart beta equity ETFs, and Goldman Sachs and JPMorgan rolled out active fixed income products. (See previous Trends & Ideas articles: "Fidelity Builds Out ETF Lineup," published Sept. 12; and "Are There Too Many Funds Coming to Market?" published Aug. 29.)

These products join a growing universe of ETFs offered by firms with a strong presence in the active mutual fund world. Examples that launched in the last year and ranked by S&P Global Market Intelligence based on performance, risk, and cost factors include Franklin LibertyQ Global Dividend (FLQD 26 Marketweight), Goldman Sachs ActiveBeta International Equity (GSIE 25 Underweight) and Legg Mason US Diversified Core ETF (UDBI 27 Overweight).

Though the asset bases for these products remain much smaller than their sponsoring firms' mutual fund products, many firms have taken incremental steps to participate in the growing ETF market.

S&P Global Market Intelligence thinks one of the side benefits of the new fiduciary standard rule could be that advisors and investors will have more low-cost products to choose from.


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