“Can they be billed on in an AUM fee model?”
“Does using them undermine my value proposition to my clients?”
“Can I be a fiduciary if I don’t consider them?”
If you’re a registered investment adviser currently deliberating about one of the most significant product evolutions in the industry today – the introduction of commission-free annuities – those are the questions dominating the conversation. But what you may not remember is that those very same questions were being deliberated just 15 years ago about exchange-traded funds, products which today have become a core part of client portfolios.
In the early 2000s, ETFs were new to the market and considered controversial for RIAs and the wrap account offerings at wirehouses and broker-dealers. Fiduciary luminary Donald Trone stoked outrage in some quarters with a column in the Aug. 22, 2005, issue of InvestmentNews entitled “ETFs and fiduciary best practices: A good fit,” merely suggesting that advisers owed it to their clients to at least consider the products when creating financial plans. That led to a follow-up in the Sept. 5, 2005 issue, “Does failure to consider ETFs breach fiduciary duty? An expert’s column, co-written with BGI, sends e-mails flying.”
At that time, the core value proposition of advisers who charged AUM fees was their ability to select and monitor the best fund managers. An essential part of due diligence prior to making a significant allocation to a fund was to interview the PM and perhaps even visit their offices to review their processes and methodologies. So there was an ethical question about whether advisers could charge AUM fees if they weren’t trying to outperform benchmarks.
The introduction of ETFs challenged that value proposition and definition of “fiduciary.” ETFs didn’t have portfolio managers. They weren’t trying to outperform benchmarks. They were built upon the academically proven notion that low-cost index investing was exceptionally difficult to consistently outperform through higher-cost active management.
Buying cheap exposure to the S&P 500, for example, was more effective over the long haul than active management of an S&P 500 fund. It took six or seven years, but ultimately the academic research showing what’s best for the client won out. ETFs were accepted as billable assets in an AUM fee model and have become a staple of most client portfolios. Today, no fiduciary would question the use of ETFs in client portfolios.
Which brings us to commission-free annuities.
Now that a wide variety of annuities have come to market in commission-free form — removing the conflict of interest for RIAs and making annuities usable in an AUM fee practice for the first time — the same questions are being asked of annuities as they were of ETFs: “If there’s little for me to manage, can I bill on them?” “Does this undermine my value proposition?” “Can I be a fiduciary if I don’t use them?”
As RIAs have grown and evolved over the past 15 years from being mere asset managers to providing holistic financial planning and wealth management services, the questions that RIAs are asking relative to commission-free annuities indicate that some in the industry still haven’t transitioned their thinking to align with their value proposition to their clients.
Clients value the outcomes their advisers deliver, not whether an investment is active or passive. Just as the academically proven strategy of low-cost index investing to get better outcomes from ETFs was more important to clients than selecting and monitoring fund managers, the same is true of annuities.
Annuities are universally supported by economists (from Nobel laureates to retirement income professors) for retirement income portfolios based on the efficiency of the income they generate (particularly in low-interest-rate environments, where they truly shine), as well as the longevity risk protection they provide and the psychological and behavioral benefits they bring to retirees.
Just as buying low-cost exposure to the S&P 500 is far superior to trying to manufacture it on your own, simply, efficiently and safely buying income through the use of a low-cost annuity is a superior solution to the riskier, more expensive, more complicated method of augmenting low-yielding bonds with the sale of equities. It’s easily demonstrated and has been proven by academics over and over for 60 years.
The introduction of commission-free annuities is a landmark development for the RIA industry, bringing a whole new set of risk mitigation and accumulation tools to help advisers deliver better client outcomes. Annuities deliver important benefits to a retirement plan that no investment product can. Yet too many RIAs dismiss the entire category based on strong biases and little working knowledge of actual products.
Assets in commission-free annuities can and should be billed upon. Their value proposition in today’s low interest rate environment is so compelling — they generate income more than 40% more efficiently on real (inflation adjusted) terms than bonds — that when considering the question “Can I be a fiduciary and not consider annuities?” the answer has to be “no.”
The barriers to fiduciary use of annuities have been lifted; they work in an RIA’s practice both from a product pricing and operational point of view. So it’s time that RIAs move beyond their historical biases about the products and start leveraging the academically proven economic and psychological benefits of annuities for their clients.
By 2030, when the biases have faded, overwhelmed by facts and data, it will be hard to believe that using an annuity was ever in question for an RIA. Just as it is now with ETFs.
David Lau is founder and CEO of DPL Financial Partners, a turnkey insurance platform for registered investment advisers.
Andrew is half-human, half-gamer. He’s also a science fiction author writing for BleeBot.