Quarterly Net Inflows Set Mark of $85.5 Billion
The latest edition of MMI Central reports a 4.9% increase in IAS assets to an all-time high of $4.59 trillion during the third quarter of 2016 compared to a 3.9% rise in the S&P 500. This edition of Central also includes a report prepared by MMI’s partner Dover Financial Research about the likely impact of the Department of Labor (DOL) Fiduciary Rule on Separately Managed Accounts (SMAs).
In the third quarter of 2016, the investment advisory solutions industry, along with the broader markets, continued to defy such perceived market headwinds as the global anticipation of the impact of Brexit, the volatility of the U.S. presidential election, and the impending implementation of the DOL rule.
Overall, IAS asset growth continued to accelerate with assets rising by nearly $214 billion in the third quarter as all market segments posted solid increases. With growth of 6.9%, Rep as Advisor (RAA) led all market segments. As in past quarters, Unified Managed Accounts (UMA) experienced strong growth, rising 6.5%, while Rep as Portfolio Manager (RPM), Mutual Fund Advisory (MFA), and SMA programs gained 5.3%, 3.9%, and 2.6%, respectively.
One-year growth for IAS was up double digits at 14.3% since the end of September 2015, a period during which the S&P rose 15.4%. UMA and RPM programs had solid gains also, showing year-over-year returns of 26.8% and 19.3%, respectively, over the trailing 12 months. MFA and RAA programs grew more slowly during this period, adding 8.8% and 13.7%, respectively. SMAs had a comparatively modest but still healthy 12-month increase of 8.2%.
The overall IAS market had record-breaking net inflows of $85.5 billion for the quarter. UMA programs once again led the way, attracting $27.2 billion in flows and accounting for almost a third of all IAS net inflows. RAA and RPM programs followed with healthy inflows of $25.9 and $23.5 billion. Mutual fund and SMA advisory programs had net inflows of $3.7 and $3.2 billion.
“The robust growth of the advisory sector is evidence that financial advisors continue to gravitate to advisory solutions to meet client needs and help scale their practices,” said Craig Pfeiffer, MMI President and CEO. “In the face of complex and difficult markets and a rapidly expanding array of financial products, we expect to see steady growth of the fee-based model, a focus on guided portfolio advice, and a continuing reorientation to achieving investors’ lifetime goals rather than beating market benchmarks.”
The New DOL Rule’s Impact on SMAs
The new fiduciary rule from the Department of Labor regarding retirement accounts requires that, with a few exceptions, the advisor must now act as the fiduciary, and broker-dealer platforms must also have fiduciary oversight with respect to retirement accounts. While sponsor firms are interpreting compliance in different ways, the likely overall result will be the same: assets will shift out of brokerage accounts and into advisory accounts.
The biggest challenges to implementation, Dover Financial found in its research, are the creation of new share classes, eliminating conflicts in sales practices, and assuring that all products and processes receive the appropriate fiduciary oversight. Broker-dealers have, therefore, mainly focused their efforts on those products that are most influenced by the DOL rule and represent the largest pools of assets: mutual funds and ETFs. In comparison, SMA vehicles have received relatively less attention due to the advisory nature of the product.
In general, SMA products and platforms are particularly well-positioned to facilitate the implementation of the new rule. SMA products are offered via advisory platforms that typically have built-in due diligence processes and oversight. SMA pricing is also lower and oftentimes unbundled when compared with mutual funds. These qualities bode well for the SMA industry.
However, the same dynamics at work across the broader financial services industry will also impact SMAs. As broker-dealers transition IRA brokerage accounts to advisory platforms, more managers and products will need to be vetted by home-office research teams. Broker-dealers will be required to rationalize all offerings across product vehicles and platforms, resulting in fewer products being offered. Large managers offering similar investment strategies in multiple wrappers will benefit from this process, while boutique managers may need to rethink their offerings to maximize presence and shelf space.
Thus, the DOL Rule is accelerating a trend that has been occurring across the industry for years – the consolidation of product offerings. Since many SMA managers and products are already covered by home-office research teams, the roster of SMA managers and products is likely more manageable for most broker-dealers, which report using 200 to 300 SMA products versus thousands of mutual fund and ETF products. As the consolidation trend continues, Dover anticipates that the number of SMAs offered will be only marginally impacted.
On the pricing side, the DOL seems to equate low cost to best interest unless there is a documented reason for charging a higher fee. This stance will increase competition between product vehicles, putting additional pressure on managers to develop new products and/or reduce fees as mutual funds, ETFS, and SMAs compete for wallet share. Those firms that have low-cost, scalable offerings will benefit the most.
This advantage is especially true of SMA fixed income products, for which managers have aggressively reduced costs through technology, improved operations, and best execution. Many SMA fixed income managers have lowered the cost of SMA laddered products to a point where they compete favorably with ETFs and broker-built laddered products.
Model-delivered SMAs may also benefit from the DOL’s focus on low cost. The DOL rule will drive the shift to lower cost, model-delivered SMA products. When comparable offerings (in terms of strategy and performance) are available in both traditional SMA and model format, advisors may need to document their criteria for selecting a higher-cost, traditional SMA.
Looking to 2017 and beyond, MMI believes that advisory solutions continue to be well-positioned for further growth driven by the business implications of the DOL rule, access to previously unserved markets now enabled by digital advice tools, and financial advisors seeking to increase their efficiencies and enhance the client experience.