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2nd Quarter 2017

The New Rule

Unpopular and Underperforming Funds? – Strange Decisions

This quarter marked the first phase of the implementation of the Fiduciary Rule.  This will have far reaching effects on the profitability of the brokerage and insurance industries.  As a result, they have been tweaking their fees, product offerings and incentives structures.
In May, Morgan Stanley followed Merrill Lynch in dropping Vanguard Funds from their platform.  This means that brokers (“financial advisors”) from the two largest brokerage firms will be prohibited from buying mutual funds for their clients from the largest mutual fund complex.  What’s going on?  According to Christine Jockle, spokeswoman for Morgan Stanley, their goal was to remove under-performing and less popular funds.  Really?  As the largest fund complex it would be hard to claim that they are unpopular.  Further, placing 14th out of 61 fund complexes in Barron’s 2016 Fund Family rankings (top quartile), they are hardly under-performing.

What Gives?

In an interview on CNBC, Bill McNabb, CEO of Vanguard, explained that they refused to pay Morgan Stanley to be on their platform. In these “pay to play” business models, the wirehouses collect huge fees from mutual fund complexes to pad their profits.  With the Fiduciary Rule becoming effective, wirehouses need to eliminate the recalcitrant firms.  McNabb added that most other advice firms (including Schwab) don’t require payment for being on their platform.  At Schwab, the custodian of your assets, there is a trading fee of $15 for lower cost mutual funds such as Vanguard.  These “pay to play” fees should raise conflict of interest concerns among investors.
Additionally, the Wall Street Journal reports that Morgan Stanley is considering the introduction of disincentives for its brokers to continue holding Vanguard Funds that were purchased before the moratorium.  How?  Through the payout grid that wirehouses use, they can significantly influence what a broker (“financial advisor”) holds for their clients.
Finally, the WSJ also reported that Morgan Stanley had created incentives to push banking products, particularly mortgages, through its “advisors”.  Last October, Bloomberg ran an article about how the Massachusetts Securities Division was initiating a complaint concerning Morgan Stanley’s mortgage sales tactics in the New England area.
Remember, the new Fiduciary Rule, as it applies to broker and insurance agents (“financial advisors”), only governs retirement accounts not taxable accounts.  Registered Investment Advisors, such as Shoreline Financial Advisors, have always been subject to fiduciary standards.