Swedroe: UK Exceeds US In Common Sense

April 06, 2015

Recent events have led me to conclude that, at least in some ways, the U.K. is ahead of the United States when it comes to investing. The first—and by far the most important—reason I have for drawing such a conclusion is that in January 2013, all licensed financial advisors in the U.K.were required to become fiduciaries and adopt a fee-for-service compensation model.

 

Transitioning to a fiduciary-only standard means that, in the U.K., selling a product and getting a commission on the transaction is no longer permitted. (In July 2013, the same also became true for advisors in Australia.)

 

There’s simply no reason for advisors in the United States not to be required to adopt a fiduciary standard of care as well, despite all the protestations from Wall Street. I can’t believe any investor who truly understood the legal difference between the fiduciary standard and the suitability standard would knowingly choose to work with someone who isn’t required to provide advice that is solely in the client’s interests.

 

There is no more logic to working with a professional who won’t offer that standard of care than there is to visiting a doctor who won’t accept the Hippocratic Oath, which requires physicians to first do no harm but also to act in the best interests of their patients.

 

What About Smaller Investors?
An often-heard argument from Wall Street is that investors with smaller accounts will lose access to affordable advice if commissions are barred as part of an industrywide conversion to the fiduciary standard. That argument holds no more water than the proverbial sieve. Anyone making that statement is likely obfuscating to protect their own interests.

 

First, a commission can easily be converted into a transparently constructed fee of the same dollar amount. The difference is that the commission is tied to the sale of a product, which might not be in the investor’s best interest. On the other hand, once a fee is paid, that fee is for advice only.

 

As a result, there’s no longer any incentive to recommend a product unless it’s in the investor’s best interest. That blows the securities industry’s entire argument out of the water. Of course, a fee would be more visible. And clients would have to write a check to specifically pay the fee. That’s why broker-dealers don’t like this idea.

 

The bottom line is that Wall Street’s opposition to the fiduciary standard doesn’t come from concern over an increase of risk and liability. They just don’t want the obligation of doing what’s best for the client instead of what’s best for them. That’s the real reason behind why the brokerage industry has gone to such great lengths to blur the line and maintain confusion and ignorance among investors. It’s the only way they can keep investors open to accepting advice that isn’t guaranteed to be in their best interest.

 

 

Some Advisors Target Small Investors
Second, there are thousands of fee-only advisors willing and able to work with investors that have smaller portfolios. Many such advisors are paid on the basis of an hourly fee, allowing them to work with investors with fewer assets.

 

Third, there are now many firms that offer financial advice to investors with smaller portfolios via the Internet and do so at very low fees.

 

In short, there’s simply no reason for the SEC to not require the fiduciary standard for anyone giving financial advice. And any elected official who doesn’t support such a proposal very clearly will not be doing their own duty to their constituents.

 

The Problem With Funds-Of-Hedge-Funds
The other investment area in which the U.K. is ahead of the U.S. relates to funds-of-hedge-funds and investor behavior. Funds-of-hedge-funds typically charge fees of 1-and-10, or 1 percent of assets plus 10 percent of gains, on top of the already high 2-and-20 fee charged by the average hedge fund.

 

Five years ago, U.K. funds of hedge funds had assets of £3 billion. Today, that’s down to less than £400 million, a drop of 87 percent. If anything, the pace of the decline has accelerated over the last few months, first as Lyxor Focus Fund was liquidated, and now Dexion Absolute and Acencia Debt Strategies are about to give back approximately half their assets to exiting shareholders.

 

In the U.S., fund-of-hedge-funds assets are down from their peak in 2007 of about $800 billion, but investors are exiting at a much slower pace. As of 2014, such funds still had about $670 billion in assets—a drop of only about 14 percent over the prior seven years.

 

David Swensen, Yale University’s chief investment officer, called funds-of-hedge-funds “a cancer on the institutional-investor world” and said they “facilitate the flow of ignorant capital.” U.K. investors appear to have taken Swensen’s advice much more seriously than investors in the U.S.

 

Adopting the fiduciary standard for all financial advisors and abandoning the scourge that is the fund-of-hedge-funds are two ways U.S. investors can improve their results. If the SEC won’t mandate the requirement for the fiduciary standard of care, then investors can solve that problem for themselves by requiring it of their advisors and demanding that their employers provide a retirement plan where the firm managing it is a fiduciary.


Larry Swedroe is the director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.

 

 

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