What Cliff Gets Right

I just digested Cliff Asness’s fresh take on the risks of implementing a Fiduciary Standard for brokers managing retirement accounts. It should be noted that people like me, investment advisor representatives (IARs) working at Registered Investment Advisory firms (RIAs) are already held to this standard. Brokers or Series 7-licensed Registered Reps are not. And then there’s this whole shady little gray area of hybrid broker-advisors which is probably going to come to an end at some point.

But brokers handling retirement accounts like IRAs have not been subject to a Fiduciary Standard of care – meaning they have not been mandated to act solely in the client’s best interest. Rather, they’ve been able to meet the more minimal “Suitability Standard”, which means they could sell commissionable products that may not meet the Fiduciary Standard but could be deemed to be suitable given a client’s net worth or level of sophistication. If the whole contrived dichotomy between these two standards of care sounds like an Orwellian exercise in bullshitting and ass-covering, well, it basically is.

I’ve been vocally in favor of increased protections for investors for the last eight years now, stemming from my hands-on experience with the suitability monster during my time at the brokerage firms.

Anyway, back to Cliff. I think he brings up a very important point about the unintended consequences of forcing this standard on the entire industry by writ. I’ve made the case recently that, rule or no, things are headed in the right direction anyway, due to investor choice, advisor preference and education / innovation. My most recent stance is: Good luck to those who don’t voluntarily become fiduciaries and if you need a law to tell you to do the right thing, then you’re probably an asshole anyway and you won’t survive. See ‘I Dare You‘ for more on this…

But it’s not that simple. Here’s Cliff, writing at AQR this weekend:

So, what do I worry about? What are the more ambiguous cases that might turn out differently under a fiduciary standard versus the regular old one? Meaning, in what instances might we now hold an advisor liable for “not acting in a client’s best interest” but wouldn’t have under the old suitability standards? More important to my argument, in what ways might upping and broadening the standard instead create other problems for investors? I can think of four prominent possibilities. First, judging investments too much by ex post performance. Second, not judging investments in a portfolio context. Third, over-emphasizing low fees as always being in the client’s best interest. Fourth, judging innovative investing approaches more harshly than conventional ones. On this last point, a strong analogy can be made to our very litigious society requiring doctors to practice “defensive medicine” — that is not done to protect the patient’s interest but to protect the doctor’s. I don’t predict this will happen here, I simply fear the possibility.

What Cliff gets right about this not being such a slam dunk in the interests of investors is the following, in my opinion:

  1. We don’t want to set up an investment industry where anything that’s not a 9-basis point Vanguard index fund is an automatic lawsuit. For obvious reasons, this would be systemically bad for the entire capital markets firmament and would end up working against the formation of businesses, employment, economic dynamism, etc. This is not the same as saying “there is too much indexing.” What Cliff and I are actually saying is that indexing shouldn’t (theoretically couldn’t) be 100% of the markets.
  2. My friend Eric Balchunas says that fund fees are the new past performance – by which he means that, these days, they seem to be the only consideration people are making. This will be seen as a mistake – after all, there are serious divergences between the Small Cap 600 index fund and the Russell 2000 index fund and a factor-driven “smart beta” small cap index. All will have different costs, but they are not interchangeable. The “cheapest” one may have the least optimal composition of stocks / sectors and not do as well as the others over a given period of time.
  3. I hate to say this out loud but we need there to be a big healthy slug of the market in which people do stupid stuff in order for good strategies to win. If everyone is being “smart” by mandate or law, then there’s less opportunity. Factors like value only work because the market periodically loses its mind for growth stocks.
  4. Selfishly, I am able to grow my firm and hire and build products and services for investors because I am able to attract assets by doing a good job. There are many advisors like me and many firms like mine. In a perfect world, there would be no one wearing the black hat, but this isn’t a perfect world. As such, when we come across a potential client who is either being taken advantage of or working with an idiot, we make short work of informing that investor. I can’t change the way other brokers or advisors behave, but I can make sure that their victims are shown the light when they come to us. Their moral failings are our opportunities.
  5. This is the most important point: We have a strong view of what constitutes quality wealth management and investing and what does not. But not everyone would agree with us. It’s not like physics wherein the universe operates according to a well-documented set of rules. Sure, there are some timeless concepts like keeping more of what you put in and not concentrating too heavily or slipping into excess speculation – but there’s a huge amount of wide open space in between with lots of room for interpretation. Cliff makes the point that even a good investment doesn’t always work out – if we’re only going to be judging the fiduciary merit of a given holding after it’s risen or fallen, then it will be a litigation free-for-all. Investments must be allowed to fall in value and still be considered prudent.

I appreciate Cliff’s thoughtful take on the topic. I recommend you check it out.


Caveat Investor? (AQR)


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