Retirement Rule Casualty: Brokers' Mutual-Fund Offerings

Is less more when it comes to investor choice? That's the question facing brokerage firms and investment advisers as they look to comply with a landmark retirement-savings rule.

Large brokerage firms typically offer thousands of mutual funds to clients. But compliance demands of the fiduciary rule, which began to take effect in June and requires stewards of tax-advantaged retirement savings to act in clients' best interests rather than their own, are causing some firms to review their offerings.

Conducting the due diligence and documentation required on so many investments can be onerous, and under the rule, some firms may face increased litigation risks. As a result, brokerages may remove some funds -- including those with higher fees or those that present perceived risks -- from their sales platforms.

"If you have more than 5,000 mutual funds on your platform, that oversight is a lot of work," said Alma Piscitello, executive vice president of Northern Lights Distributors, which provides underwriting services and counsels investment managers on fund distribution.

Some brokerage and advisory firms have already told Northern Lights of funds being pulled from brokerage platforms because of the fiduciary rule, generally because of size or expense, Ms. Piscitello said.

Under the Obama-era regulation, which aims to eliminate conflicted advice that can arise when commissions are involved, those offering financial advice to retirement savers may earn commissions and compensation that might give them an incentive to recommend one product over another, but must do so under an exemption. For advisers who use the exemption, any fees must be level with similar investment products or services. That has put mutual funds, with their varying share classes and costs, under the spotlight.

Advocates of the rule say weeding out high-cost or risky funds would benefit investors. But some managers fear the fund review will cause sales of their products to suffer and that fund expenses may be used as the key metric in the process, while financial advisers worry that funds they've used in clients' portfolios for years will be discontinued.

USA Financial hasn't cut any funds from its brokerage platform, but the Michigan-based financial-services firm has vetted its investment offerings with the fiduciary rule in mind, said Matt McGrew, the firm's chief operations officer.

If nothing changes and the rule takes full effect in January as planned, USA Financial anticipates cutting its more than 350 sales agreements across mutual funds, variable annuities, alternative investment and asset managers to "well less than 150," Mr. McGrew said.

But the rule remains in flux, with the Labor Department on Wednesday proposing to delay the compliance deadline by 18 months, which experts say suggests the rule still undergo significant revisions.

Mark Travis, president and chief executive of Intrepid Capital Management in Jacksonville Beach, Fla., said some advisers who have sold his funds for years told him recently their firms plan to stop. Clients who already have money invested in Intrepid's funds will be able to stay invested, the advisers said, but no new money will be allowed on some brokerage platforms after the rule takes full effect.

Mr. Travis said one adviser is pushing back, telling his home office that he wants to continue offering Intrepid's funds as portfolio protection for clients. But, Mr. Travis said, the adviser has been told to have "a plan B" ready.

Investor shares of Intrepid's flagship $421.9 million Intrepid Capital Fund have an expense ratio of 1.4% compared with 0.91% for the median fund in its category, according to Morningstar Inc.

"That's a significant fee hurdle," said Jason Kephart, a senior analyst at Morningstar. Still, the fund's long-term performance has been solid, he added. The fund, which focuses on protecting investors' capital, lost just 16.7% in 2008 during the financial crisis as its average peer shed 28%.

Among bigger brokerages cutting fund offerings, some cite the fiduciary rule as impetus while others say it's simply part of regular due diligence.

LPL Financial said it plans to launch a new mutual-fund platform early next year to standardize advisers' compensation to comply with the rule. The platform will offer fewer fund families than its existing platform and limit upfront commissions and trailing fees, or annual commissions.

Bank of America Corp.'s Merrill Lynch unit last year trimmed its mutual-fund offerings to 2,200 from 3,500, and expects to cut that number to 1,800 by year's end. The move is part of an enhanced due-diligence process and regular evaluation of its lineup, and not related to the fiduciary rule, a spokeswoman said.

Advisers who are using funds that have been cut from fee-based accounts can keep their existing positions, the spokeswoman said, but must do so within commission-based accounts and won't be permitted to add new assets.

To comply with the fiduciary rule, Merrill has shifted to fee-based retirement accounts with some limited exceptions.

Advocates of the rule had hoped it would lead to a re-evaluation of investment offerings. The Obama administration said its goal in pursuing the rule was to protect unwitting individual investors from conflicted advice, which it said costs American families billions of dollars a year and pushes down annual returns on their retirement savings.

"It was always a feature of this rule that it was going to force investment products to compete under a best-interest standard instead of competing to be sold by paying the broker more generously," said Barbara Roper, director of investor protection at the Consumer Federation of America. "Forcing investment products to compete based on cost and quality will be best for investors, even if every decision made in narrowing these fund menus doesn't optimize the outcome."

(END) Dow Jones Newswires

August 12, 2017 07:14 ET (11:14 GMT)