How a best-interest rule could put blinders on advisors

How a best-interest rule could put blinders on advisors

How a best-interest rule could put blinders on advisors The rise of passive investment products has been driven significantly by one reality: expenses and fees are a critical factor in determining the performance of a fund. But there are plenty of other features to consider — and advisors could be in danger of forgetting that.

In their latest annual survey, and Brown Brothers Harriman & Co. found that financial professionals in the US are placing greater importance on finding the ETFs with the lowest expense ratios for clients’ portfolios. This is primarily due to increased awareness of their fiduciary obligations, reported the Wall Street Journal.

The conclusions were based on responses from 360 professional money managers, which were primarily financial advisors. Also polled were registered investment advisors, brokers at major wirehouses, and regional broker-dealer firms.

Among the respondents, 64% said expense ratios were “very important” in ETF selection, while 29% said they were “somewhat important.” The next highest priority identified this year was index methodology, with 52% saying it’s “very important” and 37% considering it “somewhat important.” The factors considered to be less significant were an ETF’s historical performance, tax efficiency, trading volume, trading spreads, issuer, and tracking error.

Last year, only 25% of respondents deemed costs as important. However, the survey phrased the question differently at the time; it asked respondents to rank different ETF factors by importance from one to seven, with one being the “most important.”

Since last year’s survey, the US Department of Labor’s (DOL) fiduciary rule has undergone its initial implementation. The rule requires advisors handling retirement accounts to make decisions and recommendations based on their clients’ best interest. There have been similar calls for a best-interest standard from Canadian investors, though regulators and industry groups have said it would be challenging.

“While the Trump administration has delayed the rule’s full implementation, it nevertheless spurred growing awareness of fiduciary obligations and the toll fees take on investment portfolios,” the Journal said, noting that 53% of the respondents to the survey said those obligations were a major concern in their evaluation of investment products’ costs.

“There is an incredible understanding [among the respondents] of what impact the cost can have on the performance of the fund,” Ryan Sullivan, vice president of global ETF servicing at Brown Brothers Harriman, told the Journal. He said that going for the lowest cost is one of several ways advisors can assure clients that they’re upholding their fiduciary duty.

Expense ratios often make up the lion’s share of an ETF’s cost. But tracking errors, trading costs, and degree of tax efficiency also affect the performance of an ETF. Sullivan noted that advisors may also point to efforts they make to understand their clients’ financial situation and objectives, as well as due diligence to determine product suitability, as proof of their adherence to their obligations.

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