Whatever happens to the Department of Labor fiduciary rule, the mutual fund industry is moving into a “fiduciary era.” For one thing, investment advisors hope to capitalize on investors’ heightened awareness of the role of a fiduciary. For another, the backlog of regulatory change that must be implemented is large and there are many processes in place that were implemented with time to market not efficiency of execution that need to be addressed.
Besides demanding ever-greater levels of transparency, regulators are also beginning to turn their attention to RegTech, to ensure investment firms have the systems to manage compliance workloads. As we look ahead to a future dominated by financial technology, it’s becoming clear that when it comes to data management, only the fittest will survive.
To square the growing regulatory costs of doing business with the downward pressure on fees, broker-dealers are reinventing their revenue models. And big brand name distributors, committed to creating more compliant businesses, are making structural changes to their platforms to prepare them for whatever the future holds.
So, if product and operational changes made to comply with the fiduciary rule have changed the rules of the game, which mutual fund industry practices will live on?
- An industry split over commissions: While some major broker-dealers have vowed to kill off commissions in retirement accounts altogether, the majority of them expect to continue to support commission-based business – with many firms offering separate or hybrid platforms for advisors. Some advisors may revert to commissions. But the publicity around fiduciary responsibility has given impetus to fee-based models of compensation.
- Industry fragmentation: In an advice-centric world, broker-dealers will continue to shift towards delivering financial advice themselves, or provide better service to financial advisors who deliver advice. To compete, broker-dealers are going to have to offer better solutions and technical support for centralized back-office operational functions, including compliance.
We’ll likely see three broker-dealer models going forward, with different compliance obligations, products and services: level-fee fiduciary broker-dealers, which benefit from recurring revenue, smaller providers with commission based legacy models, and broker-dealers wishing to serve customers on both a commission and fee basis.
- Endangered commissions: Under fiduciary rule, brokers are free to charge higher fees, as long as they are the same across all their funds. But to avoid the appearance of a conflict of interest, the industry is abandoning traditional A shares, which charge 5.75% commission, and embracing a new T-share or “transaction” share class, with a uniform 2.5% front-end load and a 0.25% trailing 12b-1 commission rate – and many firms are even dispensing with the 12b-1 fees.
While some question the purpose of T shares, in the event that the fiduciary rule is rolled back – a 2.5% sales charge on bond funds is a tough sell in a low interest environment – level fees are probably here to stay, given the cost-consciousness of investors. Moreover, broker-dealers with fee-based recurring revenue command higher valuations than purely-commission-based firms.
- Passive investing: The change in fee structures designed to achieve level compensation was clearly established by low-cost passive investments, though the appropriate balance between active and passive will still depend on individual investors’ needs. In turn, increased competition among passive fund managers will continue to drive down the cost of passive investing, putting further downward pressure on actively managed fund fees. As is the case above with fee compression, the heightened awareness on the part of investors is a driver of the shift to passive strategies.
- Compliance and regulatory tech spending is set to rise: With major broker-dealers making their platforms more transparent and streamlined, and the cost of supporting different models rising, mid-sized firms have been caught flatfooted. After years of cost cutting in the back office, spending on technology has become a question of survival. Yet, even at this time of tumultuous change, only the biggest firms have invested heavily in dedicated regulatory technology. Smaller mutual fund distributors, only 20% of whom have spent any money on enterprise data management systems “We should site attribution to Thompson Reuters here, may seek economies of scale as they realize the time for waiting has passed.
In spite of the determination of the new administration to reign back regulatory overkill, and force regulators to justify the costs of their regulations, mutual fund distributors still face challenges that will separate the strong from the weak. With the cost of doing business rising in line with the volume and complexity of data, super-platforms that have committed to investments in technology have a clear advantage. Technological support is going to be a key differentiator – and one that will benefit from scale as the number of information requests from regulators continues to grow.
Contact Delta Data to learn more about how we can help you stay ahead of the change.
About Delta Data
Delta Data provides the back-end solutions that companies in the mutual funds industry use to process billions of dollars of transactions and keep on top of their data.