Much regulatory and legislative activity since the financial crisis of 2008-09 has focused upon the desirability of providing a comprehensive fiduciary standard of care within the financial services industry. The general (if superficial) assumption — and one I share — is that investors would benefit from the application of this higher standard of care throughout the entire industry. It seems axiomatic that if investment professionals put their clients’ interests ahead of their own, clients should benefit. This year’s Quantitative Analysis of Investor Behavior from DALBAR examines that assumption.
The 2012 QAIB concludes that:
- It is impractical to try to distinguish between “selling” and “recommending;”
- The number of available professionals may become limited on account of anticipated lower compensation due to the implementation of a fiduciary standard, so a fiduciary relationship should demand a premium;
- Investment professionals should develop and use a pricing structure reflective of the time spent and the skill level of the practitioner as well as reflecting both fees for services rendered and compensation for achieving desired results; and
- A universal fiduciary standard “will limit a professional’s willingness to introduce any but the lowest risk investment alternatives” and negates the value of creating portfolios “that reflect the investors’ goals,” suggesting the need to use a process that allows clients to make informed decisions with full knowledge of expected returns and potential losses.
There is much to commend these areas of inquiry and further research is indeed warranted in these areas. I agree that it is impractical to try to distinguish between “selling” and “recommending.” However, I am less convinced that lower compensation via a universal fiduciary standard will result in fewer competent advisors, particularly since finance professionals are exceedingly well paid overall. Even after a 16 percent decrease and a wide disparity between top and bottom, Goldman Sachs employee average pay exceeds $135,000. I’m not even certain that overall compensation will ultimately be reduced (even if I expect it to — the greater risk is that it will be harder for newer professionals to enter the field because fee-based business builds “critical mass” much more slowly). I also suspect that advisor pricing will sort itself out.
The QAIB doesn’t mention structural challenges to a uniform fiduciary standard. For example, in the same way that a Ford salesman cannot be expected to recommend a Chevy even when it’s in the customer’s best interest, how can we expect a fiduciary advisor to deal with products that may serve a client’s needs but are not available on his employer’s platform?
The most interesting potential area of inquiry is how a fiduciary standard impacts investment strategy. I don’t see the fiduciary advisors I know being afraid to recommend portfolios with a modicum of appropriate risk. Failing to meet one’s goals by earning too little on one’s investments, while a longer-term risk, is no less significant a risk than general drawdowns and no less subject to client complaints. Moreover, while fiduciary advisors have been quick to criticize the NBER “advisor sting” study as inherently flawed and not applicable to them (for example, here and here), despite the intuitive appeal of the idea that fiduciary portfolios ought to outperform non-fiduciary ones, it remains unsettled as to whether that is actually true. I am anxious to see a comprehensive study comparing performance data from and of fiduciary and non-fiduciary advisors. Then we can begin to answer the question posed by the title of this post and by the 2012 QAIB: Do Fiduciaries Produce Better Returns?
Edited to add (4.18.12 @ 2:30pm PT): My friend Gil Weinreich of AdvisorOne followed my lead here and asked Lou Harvey of Dalbar about this issue. You may read about it here.