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Cliff Asness Pokes a Big Hole in the Fiduciary Rule

By Murray Coleman January 30, 2017

Whether Donald Trump's administration decides to dump the pending DOL rule or not, indie RIAs argue that clients are going to keep demanding that advisors act in their best interests at all times.

In such terms, the Department of Labor’s rule to raise fiduciary standards in retirement planning “seems like a no-brainer,” according to star alternatives fund manager Cliff Asness.

The head of alts pioneer AQR Capital Management, which manages more than $175 billion, suggests in a new blog that “legislation or regulation that says people must be good doesn’t actually ensure they will be good.”

That’s not a new complaint. But Asness digs deeper to note that advisors being scrutinized on the investment side – as portfolio managers – face an even murkier future in any push to regulate proper behavior.

As he puts it: “Do we all agree enough on what’s actually in an investor’s best interest to make this rule a fair and equitable way to judge advisors? Investing is a very contentious field with lots of disagreement over even the very basics and it has lots of randomness, so this is not a no-brainer.”

Advisors can be great fiduciaries but good intentions are only part of the equation for helping clients reach their long-term financial goals, agrees Mark Armbruster, president of Armbruster Capital Management, which manages about $315 million.

The Pittsford, N.Y.-based advisor sees Asness as voicing a common concern of even the most bullish DOL rule supporters. “A portfolio manager who doesn’t sufficiently understand how an investment works – or the nuances of applying strategic market analysis into portfolios – is a recipe for underperformance over time,” says Armbruster, who describes himself as a fan of stricter fiduciary standards.

Another possible loophole in trying to legislate how advisors match products with their clients’ best interests is the random nature of returns, says Dean Harman, an advisor in suburban Houston.

Besides running an independent RIA, he serves on the board of the Financial Services Institute. The FSI represents about 39,000 independent advisors and broker-dealers.

Harman, whose fiduciary-based practice manages about $200 million, has testified before Congress about the DOL rule. “A big issue in this industry is a wide disparity in outcomes among client portfolios – they’re all over the place,” he says.

A recent research report he’s read estimates that model portfolios run and designed by retail advisors can be expected on average to underperform big institutional money managers by around 3.15% over longer stretches.

“The role of an investment advisor across both brokerages and independent RIAs is highly diverse – so are the individual needs of their clients,” Harman says. Stricter fiduciary standards, he warns, could come with “unintended consequences” like increased lawsuits and less innovation in portfolio construction.

A more cookie-cutter approach and heightened sensitivity to legal issues is a concern also raised by Asness. Harman takes it a step further: “In general, the real challenge facing this industry is that too many advisors don’t follow best practices in terms of running model portfolios across their practices.”

For example, in his practice a relatively conservative portfolio with about 30% in stocks might be compared to a similar benchmark using Morningstar’s institutional database.

Kevin Grimes

“We can not only compare the most recent results of clients using a similar asset mix,” Harman says, “but we’re also able to extract data from their system to see where that type of portfolio might rank in the industry.”

Fiduciary rules can get tricky when trying to keep fees relatively low for clients, says Kevin Grimes, CIO at Grimes & Co. in Westborough, Mass., an indie wealth manager which manages nearly $2 billion. “But you’ve got to thoughtfully balance the value of asking someone to pay a little more in exchange for gaining exposure to other parts of the market that wouldn’t be possible otherwise,” Grimes says.

Coming regs or not, Grimes & Co.’s investment process starts with an “expense budget” for each type of portfolio. Taken into account are the blended expense ratios between actively managed mutual funds and passive ETFs. Position weightings are also considered.

“This sort of breakdown really helps our clients to understand just why and how we’re using active managers,” Grimes says.

Such a strategy also shifts conversations away from purely fund costs to fund placement.

“What we really want to drive the dialogue towards is back up to the portfolio level – how everything is working together,” Grimes says. “If you simply talk to people account by account, then you’re looking at the trees instead of the forest.”