Ferri: Let’s Celebrate The Independent Advisor

With the Fourth of July fast approaching, I am reminded of the many benefits of independence, especially independent investment advice. You would think that independent advice would be any adviser’s highest calling. Surely our mission should be to aggressively avoid direct or indirect conflicts of interest, so we can freely employ any funds or investments that best suit our clients’ needs.

Investors should expect this highest level of care from their adviser, and they should ignore recommendations made by any firm that won’t look at all the options available in the marketplace. Yet, I routinely see conflicts of interest from advisers that restrict their clients to a limited investment list.

When I was a broker during the 1990s, the firms I worked for encouraged us to sell their proprietary mutual funds. Many competing funds were more appropriate and lower cost, but we were told to recommend in-house funds first.

Suitable Vs. Individual

This sounds improper, but it is not a breach of the suitability standard that governs a broker’s advice. The liberal suitability standard allows a broker to sell in-house financial products as long as the broker can show that they are suitable for a client based on the circumstances. However, being suitable for a client is decidedly not the same as being the best available choice for that individual.

By law, a broker is not a Registered Investment Adviser (RIA), so they do not fall under the stricter fiduciary standard that RIAs must follow. The fiduciary standard is a much higher standard of care than suitability. As described by the Securities Industry and Financial Markets Association (SIFMA), “Fiduciary duty includes both a duty of care and a duty of loyalty. … [T]hese duties require a fiduciary to act in the best interest of the customer, and to provide full and fair disclosure of material facts and conflicts of interest.”

A disturbing new trend in the advisor industry is to limit investment options for clients. When I see a firm restricting its investment recommendations to only its own proprietary funds or limiting portfolios to only exchange-traded funds (ETFs), I must question whether these decisions are in the best interest of clients. These are the elements of a suitability standard, not a fiduciary standard.

One behemoth mutual fund company who will remain nameless has recently launched an advisory service that charges clients a separate fee to choose their funds and manage a portfolio. The company restricts client portfolios to only their own proprietary mutual funds for which they are also paid fees.

They do not recommend competing mutual funds even when those products may be a better fit for their client.

Sound familiar? It’s the suitability standard for brokers that I described earlier.

Robo Advisors

Here’s another example. There is a growing presence in the marketplace of automated portfolio management services that use ETFs exclusively in their core portfolio management offering. These firms are often referred to as robo-advisors. Investors take a questionnaire on-line, are served up a portfolio of ETFs, and then asked to open an account and invest, all without speaking with a human being.

Why do most robo-advisors only use ETFs and exclude mutual funds? It’s not because mutual funds don’t offer broad, low-cost investment opportunities, nor is it because ETFs are better than traditional funds. It’s because the robo-advisors haven’t figured out how to efficiently include mutual funds in a portfolio due to trading issues and settlement differences with ETFs.

A fiduciary is not biased; they act in the best interest of the client and provide full and fair disclosure of material facts and conflicts of interest. Restricting client portfolios to a narrow set of investments because it benefits of the adviser runs contrary to this ideal.

Being a great steward of clients’ money isn’t easy, and no investment adviser is perfect. I’m proud to say that my firm, Portfolio Solutions®, has never restricted clients to one mutual fund company or to ETFs only. When we believe an investment best fits a client’s needs, we use it. That’s adviser independence. That’s the way it should be.

For a full list of relevant disclosures, click here. Rick Ferri, founder of Michigan-based Portfolio Solutions, is a widely recognized index investor and the author of several books on index investing.