“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.
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