Financial advice: New race for the saver’s dollar

As plans to cut fees on US retirement products draw fire from providers, ‘robo-advisers’ lay in wait

 

©FT montage; Dreamstime

'Robo-advisers' are increasingly common as the Obama administration plans to tighten regulation on fees and commissions

 

 

With barely 300 days remaining of his presidency, Barack Obama is fighting to push through his last big financial reform before he leaves office — and once again, large sections of the industry have united to try to stop him.

 

The administration is close to finalising proposals that will radically change the way retirement products are sold to Americans, introducing a new “fiduciary standard” that the president says will sweep away hidden fees, egregious commissions and conflicts of interest that cost savers billions of dollars a year. But wealth managers and other retirement specialists contend that a key provision — a watertight legal requirement to put their clients’ interests first — is simply too onerous and will leave the poorest savers struggling to find advice.

 

Even before the final proposal is published, it is clear that some of the most lucrative products and practices will be in jeopardy under the new standard, with life insurance companies and retail brokers among the likely losers. A new breed of “robo-advisers”, which rely on computer algorithms to generate savings advice for less than the cost of human brokers, are among the few sure-fire winners. As for whether the American retirement saver wins or loses, that depends on who you ask.

 

“We have millions of investors, particularly in mutual funds, depending on us for their lifetime’s security and we haven’t done a good enough job putting their interests first,” says Jack Bogle, who founded Vanguard, the fund manager, and who has long campaigned for a fiduciary standard to cover financial advice and savings products. “Anybody who touches other people’s money should be deemed to be a fiduciary.”

 

Tightening the standard

 

US financial advisers have been held to a fiduciary standard that requires them to put their client’s interest above their own since the Investment Advisers Act of 1940. But many of the other professionals who dispense advice are not. Staff at the country’s 5,100 broker-dealer firms, plus thousands of call-centre operatives at mutual fund companies, salespeople from insurance firms and a host of others, are only required to recommend “suitable” products.

That leaves them free to make recommendations that factor in the fees and commissions they receive on the products and — the Obama administration says — push savers into higher-cost products that stunt the growth of their retirement nest eggs. The administration says returns could be improved by, on average, 1 percentage point annually if savers were put into the best products, rather than just “suitable” ones that generate the highest fees — and the difference would help narrow the gulf between what Americans are saving and what they will need for retirement.

 

 

Not true, says the chief executive of one of the largest networks of broker-dealers in the US. “It will sound cute, but my opinion is this is a solution searching for a problem,” says Jim Weddle, managing partner at Missouri-headquartered Edward Jones, which has 14,400 partners offering advice either for a fee or on commission. “I do not see a problem. If a financial adviser or a firm regularly does other than putting clients’ interests first, they are not in business very long.”

 

The fiduciary rule is being drawn up by the US Department of Labor, whose responsibility for overseeing retirement investment has expanded since the days when employers’ defined benefit pension plans were the dominant savings vehicle. A complementary effort to introduce a similar fiduciary standard across non-retirement savings products was introduced in the Dodd-Frank Wall Street reform act, but is stalled at the Securities and Exchange Commission.

 

The DoL’s effort is, therefore, more limited in scope than that introduced earlier this decade in the UK, where the Retail Distribution Review effectively ended commission payments on many products. Under a draft of the US rule, published last year, such payments will be allowed, but only under defined circumstances and as disclosed in a legal “best interest contract” to be agreed with the customer.

 

Both sides look to the UK for evidence of what might happen under the new regime. Edward Jones pulled out of Britain as the RDR was in its infancy. “We could see it coming, and we thought this isn’t going to play well, and I don’t think it has,” Mr Weddle says. “The account minimums [the amount a customer must have to invest before an adviser will take them on] have gone sky high. The DoL points to the UK as an example of where this has worked; we would disagree.”

The DoL has indicated it hopes to have the new standards implemented by the time Mr Obama leaves office next January, a final victory in what has been a long battle with the wealth management industry. The DoL initially proposed a fiduciary rule in 2010, only to withdraw it the following year after objections that it would be unworkable as first drafted. In the deluge of more than 7,000 comment letters on the 2015 drafts, most objectors disputed not the principle so much as the devilish details. A final version is expected to be published within weeks.

Opponents still hope to block the proposal in Congress or the courts. Paul Ryan, the Republican Speaker of the House of Representatives, has vowed to block the rule, although a presidential veto limits Congressional options. Industry players are highly likely to launch a legal challenge, but there is only an outside chance that they will get an injunction to prevent its implementation before the case is heard.

Preparing for change

However reluctantly, the industry has started to gird itself for upheaval. Compliance will require advisers to take a deeper look into a saver’s circumstances, and keep a better paper trail of their work, as well as to build in the risk of litigation down the road. That will raise costs.

Arrangements between brokers, the distributors of financial products, and the mutual fund and life companies — the manufacturers, in industry parlance — are also having to be rewritten. Margins are expected to come under pressure at firms that rely on commission payments and continual “distribution fees” that are built into funds’ annual costs. Revenues of $2.4bn a year could be under threat from the fees built into US mutual fund sales alone, according to a Morningstar estimate.

There are also question marks about whether many of the most complicated retirement products will still fit into the country’s $7tn of retirement accounts. Among those that may not pass muster are non-traded real estate investment trusts, according to several executives, and many of the most complicated annuities — a concern that has been exercising shareholders of life insurers.

“Most people in the industry would say they’ve never seen a bigger change of regulations in their careers,” says Lee Covington, the Insured Retirement Institute’s general counsel. He describes the proposals as “highly detrimental”.

Over the past decade $1.5tn of variable annuities have been sold, according to the trade body Limra. About half the sales are estimated to be purchased through retirement vehicles, making them vulnerable to the overhaul.

Proponents of the products argue that they combine the benefits of holding an equities mutual fund — creating the potential for racy investment returns — with protection against losses or the investor running out of money. Critics say they contain some of the largest upfront fees, with commissions typically between 7 and 9 per cent, and surrender penalties for cancellation.

Despite a decline in sales and the difficulty for insurers of managing annuities in a low interest rate environment, they still generate big profits for several groups. For Lincoln Financial, the third-largest listed US life insurer by assets, VAs are forecast to account for almost half its earnings this year.

Tremors are expected to be felt on the other side of the Atlantic, too. US annuities are among the most important products for several large European life and pensions companies. Transamerica, an arm of the Dutch insurer Aegon, and Paris-based Axa rank among the 10 biggest VA providers.

The biggest as of the end of last year was Jackson National Life, an arm of the UK-listed Prudential, which has been taking market share. Barry Stowe, who runs the Pru’s American arm, told analysts this month that “you will have lawsuits” if the overhaul “goes too far”.

Tweaking the model

Even though the rules have yet to be published, insurers are already repositioning. MetLife last month agreed to sell its 4,000-strong network of agents. AIG has also sold its network of broker-dealers. Both companies have acknowledged that the DoL reforms are part of the rationale for the moves. The Pru, Lincoln and others have argued that even a worst-case scenario for VAs would be manageable for the companies, and the disruption could lead to opportunities to win market share.

 

That is the hope of some retail brokerages, too. While many still operate out of “mom and pop” shops, the largest regional and national chains hope to cherry-pick staff and small acquisitions as the industry consolidates. Stifel, another Missouri-based company with a large broker-dealer network, says that if it ends up shifting clients to a fee-based advice model, its revenue per account would actually increase.

 

But Stifel’s chairman, Ronald Kruszewski, says it is impossible to predict how many clients want to pay a regular fee, while those that continue to let their broker take commissions could quickly get mired in the details of the DoL’s “best interest contract”, which approves some products and not others.

Mr Kruszewski raises the issue of what will constitute advice in the new regime. “Simply, there are lots of complexities here; any time you try to have a rules-based regime with very detailed rules, they tend not to work,” he says.

Across the industry, players are reassessing all of their potential interactions between financial professionals and the public. Insurers are considering reshaping their annuity product range.

Retail brokers are examining whether to introduce new minimum balances for clients, where previously they have not imposed such lower wealth limits.

But amid the overhaul, there is one set of companies that are doing little more than sitting and waiting for new customers to arrive. Robo-adviser firms such as WealthFront and Betterment, while tiny compared with the US savings market, are expecting to pick up customers — particularly younger ones.

After 3,400 of those comment letters had rolled into the DoL, most critical of some or all of the new rules, Jon Stein and Eli Broverman, Betterment’s founders, fired off a letter of their own.

“Behind all the rhetoric is an age-old dynamic,” they wrote. “There are those who are busy building innovative services to better serve consumers, and then there are the rent-seeking incumbents who are busy deploying their formidable resources lobbying to preserve the status quo.”

Mr Bogle seized on Morningstar’s estimate of annual revenue losses for the wealth management industry. “If providers lose $2.4bn, investors are $2.4bn better off. This is not complicated,” he says.

The UK: New ‘guidance’ regime slow to scale up

Until recently, the response of UK policymakers to the charge that thousands of investors were no longer getting financial advice as a result of regulatory changes was both blunt and withering. “The vast majority of those people weren’t really getting advice,” said Martin Wheatley, the former head of the Financial Conduct Authority, in 2013. “They were just getting a sales pitch.” In the six years that it took to get the UK’s Retail Distribution Review on to the statute book, there were repeated warnings that it would lead to an “advice gap”. A 2012 survey by Fidelity and Cass Business School suggested that three-quarters of UK savers had insufficient assets for them to be of interest to fee-charging advisers. The first to withdraw from advisory services were the high street banks, pursued by fines for mis-selling. Private banks and wealth managers soon jacked up their minimum requirements for assets under management. Many independent advisers, irked by rising liability insurance costs and the fact they had to pass new exams despite decades of experience, left the industry. Regulators hoped their place would be taken by “guidance” providers and technology. Yet this has been slow to start, in part because potential providers are concerned about the legal distinction between advice and guidance. In response, the recent Financial Advice Market Review recommended that the UK definition of advice is aligned with the EU’s. There have been some beneficiaries. Companies with the scale to service less well-off clients profitably have been able to hoover them up; assets under management at Hargreaves Lansdown have almost doubled to £58bn since the RDR. At St James’s Place, which offers an advice-based service, assets have grown almost 70 per cent. Jonathan Eley

Barack Obama has risked US credibility in the Middle East

America is not fated to fall from grace but much will depend on future leaders, writes Nicholas Burns

 

©Reuters

 

 

Jeffrey Goldberg’s brilliantly composed portrait of Barack Obama’s foreign policy mindset in the The Atlantic is a landmark achievement. It also helps to explain why the US is today a halting and uncertain power in global politics.

 

Mr Obama will leave office with important international achievements in place, among them the Iran Deal, a historic climate change pact and the Asia and Europe trade agreements. He has also conducted himself with grace and dignity in office.

The US president was right to focus his conversations with Mr Goldberg on perhaps the most difficult question in American foreign policy: when should presidents order the military to intervene in wars beyond its borders and when should they not?

In doing so, however, he seems determined to contest principles that recent presidents have found vitally important in the exercise of American power. Here is where the emerging “Obama Doctrine” often comes up short.

 

Through all the successes and failures of America’s global strategy since the end of the Cold War, we have understood what works. We know, for example, that American diplomacy is most often effective when it is backed by a strong military and the willingness to threaten force when necessary.
 

This is why Mr Obama’s defence of his decision to pull back from striking Syrian military targets in 2013, after having drawn a “red line” against Bashar al-Assad’s use of chemical weapons, is so troubling. He adamantly rejects the notion that his restraint diminished US credibility in the region.

 

However much Mr Obama may believe the old rules do not apply, it is an ancient truth that a great power has to back up its threats if it wishes to be respected by its friends and feared by its adversaries.

If Mr Obama did not intend to honour his red-line threat, he should never have made it. The result was inevitable — American credibility is undeniably diminished in the Middle East while that of Vladimir Putin’s Russia has been enhanced.
 

We also know that America’s vast network of alliances and security partnerships in Europe and Asia is a key element of its global strength. That is why the president’s criticism of two of America’s closest allies, Britain and France, as “free riders” in their prosecution of Nato’s Libya campaign in 2011 was so counter-productive.

 

Americans sometimes forget that the US military accounts for roughly 75 per cent of all Nato defence spending. It may not be fair but Nato has always been a US-led alliance. The real mistake in Libya was Mr Obama’s decision to allow the US to take a secondary role in an important Nato mission for the first time in its history.

US presidents have also learnt that it almost never works to embarrass a friend publicly. Mr Obama’s remarks about the Saudi royal family were inappropriate. He should have directed his darts not at America’s friends but at its true adversaries — Iran, Hizbollah, the Syrian government and Russia.

There is an unwritten rule of public diplomacy: argue with your allies behind closed doors rather than in the press, lest you weaken them and strengthen their opponents.

The US is not fated to fall from grace in the decades ahead but much will depend on the determination of its leaders. To paraphrase John F Kennedy, America can be as big as it wants.

Mr Obama’s emphasis on what the US should not do rather than on what it should, suggests the limitations he has placed on policy.
 
He is right about one thing, however: this is a time to return to diplomacy. He still has time to present a larger, more expansive view of what America can and should achieve in the world. It would be reassuring, though, if the president acknowledged that combining diplomacy with military strength is not a relic from an antiquated “Washington playbook”. On the contrary, it is the surest way for a great power to find success and peace in a complicated and dangerous world.


The writer is a professor at Harvard’s Kennedy School, currently on leave at Stanford, and a former undersecretary of state

The narcotics business

Five former presidents demand an end to the war on drugs

But don’t hold your breath—a UN summit on drugs next month looks likely to be a flop
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AS THE drug war has rumbled on, with little to show for all the money and violence, its critics have become a more diverse bunch than the hippies and libertarians who first backed drug reform. The latest broadside against prohibition was fired on March 24th by a group of former heads of state and businesspeople, who put forward a sober case for rethinking the international approach to drug control.

“Ending the War on Drugs” is a collection of essays by former presidents of Brazil, Mexico, Colombia, Nigeria and Switzerland, as well as a former deputy prime minister of Britain and assorted scientific folk. George Soros, a financier who has bankrolled many pro-legalisation pressure groups, provides a chapter; the book carries an introduction by Richard Branson, a business mogul whose company, Virgin, is its publisher. All condemn what they see as a political, economic and public-health failure.

The arguments are well-rehearsed but bear repeating, especially when made by such a diverse and level-headed group. In spite of its vast cost to taxpayers (estimated by the authors at $100 billion per year) the war against drugs has failed to stop people taking them, instead driving up the price of narcotics to the point where they generate upwards of $300 billion a year for their dealers and traffickers. More than 1.4m drug arrests are made each year in America alone, and they are unevenly distributed, with black Americans jailed for drug offences at ten times the rate of whites, the authors write.

Latin America has borne the brunt of the war, and perhaps the sharpest chapter is by Ernesto Zedillo, who witnessed the narcotics industry’s destructive, corrupting power as president of Mexico in 1994-2000 (even his drug tsar turned out to be working for the Juárez cartel). He spells out that merely decriminalising consumption—in effect, downgrading drug-taking from a serious offence to something more like a parking violation—is inadequate, since it leaves the supply side of the business in the hands of the mob. Indeed, “decriminalising consumption without taking away from organised crime the provision of the supply of drugs would be counterproductive, even disastrous,” he argues. Governments should “intelligently regulate”—that is, legalise—drug markets, he concludes.

The arguments are aimed at the diplomats who next month will gather in New York for a special session of the UN General Assembly to discuss the question of drugs. The last such session was in 1998, when the summit’s slogan was “A drug-free world: we can do it”. That aim has been missed in spectacular fashion—indeed, the consumption of most drugs has risen steeply. Yet the signs are that this year’s summit will be little more enlightened. A meeting of the Commission on Narcotic Drugs, another UN organ, ended on March 22nd with a draft declaration that failed even to criticise the use of the death penalty for drug offences, something that reformers had previously hoped might be achieved as a minimum.

The arguments of the ex-presidents and their allies are persuading growing numbers of the need for a rethink—not least in America, once the arch drug-warrior, where more than half the population now wants to legalise cannabis, and more and more states are doing just that. The trouble is that changing the UN conventions that mandate worldwide prohibition would require the agreement of all 193 member states, and plenty are still firmly against even tentative reform. The most likely outcome of next month’s powwow is more waffle, and a growing realisation that the UN drug conventions will not be reformed but simply ignored.

Reckoning With Inequality

Jeffrey Frankel

Lloyd's of London Takes `Massive Hit' From Low Returns

by Sarah Jones 


Lloyd’s of London reported a 30 percent drop of full-year profit as the world’s largest insurance market was hurt by continued pressure on pricing and the lowest investment returns since at least 2001.

Earnings declined to 2.1 billion pounds ($3 billion) for 2015 as income from investments, primarily in fixed income, sank 60 percent to 400 million pounds with the majority earned in the first half of the year, according to the company’s annual report Wednesday. Weaker insurance pricing in 2015 is expected to continue this year, hurting profitability.

“We’ve taken a double hit from reduced margins in underwriting and lower investment yield,” Chief Executive Officer Inga Beale said in an interview with Bloomberg Television Wednesday.

“On the investment side we saw a dramatic reduction in 2015 that was a massive hit” to earnings.

Beale said the low interest-rate environment and a “healthy” return on capital of 9.1 percent continued to attract new money into the industry, placing further pressure on insurance rates that have already seen double-digit declines. Pricing is falling at a time when natural disasters are on the rise, circumstances that would previously have sent rates higher, she said.

Shock Event

“We’re not actually sure if the old-fashioned way of doing business is going to happen again,” Beale said in a separate interview. “Now people are saying there is so much capital swilling around that one shock event wouldn’t have an immediate effect. It doesn’t seem to tally.”

Beale’s comments echo those of Aon Plc’s Greg Case, who said that it would take “multiple Hurricane Katrinas,” which cost the industry $41.1 billion, to absorb the excess capital that’s available to underwrite risk.

Lloyd’s so-called combined ratio rose to 90 percent from 88.4 percent amid higher claims in the energy sector and the explosion at Tianjin Port in China. An increase in the ratio indicates a deterioration in profitability.

“We would be concerned if we saw ill-disciplined underwriting, but these figure still look good,” said Beale, referring to the 9.1 percent return on capital. Given the low interest rates “for many investors that are looking at that figure, they would ask what’s your problem?” she said.