It should help your clients sleep better at night knowing they’re in the most investor-friendly nation in the world. The U.S. received the highest score in Morningstar’s Global Fund Investor Experience report, with top grades for its low fund expenses and strong disclosure practices. But analysts pointed out areas for improvement, including sales practices, regulation and taxation.
For one, U.S. regulators seem to be understaffed and may not be able to handle the necessary supervision and oversight.
While the U.S. Securities and Exchange Commission is the primary regulator for the fund industry, the Commodities Futures Trading Commission steps in when a fund invests in derivatives tied to commodities. The Department of Labor’s fiduciary rule, part of which went into effect in June, also affects mutual fund sales. And the Financial Industry Regulatory Authority regulates U.S. securities firms who are distributing sales literature and the funds themselves.
“This overlap among multiple regulatory entities has the potential to create confusion and inconsistencies both for fund companies and for investors,” the report said. “Unified regulatory leadership would be preferable to the competing standards currently in place.”
In addition, there is no regulatory framework in the U.S. regarding soft-dollar arrangements, something Morningstar frowns upon. The researcher defines soft-dollar commissions as “brokerage commissions that the fund does not pay with cash but rather with other goods or services that it purchases from the broker that executes the trades.”
“Unlike some other countries, there is no requirement that soft dollars be used exclusively for the benefit of the fund’s research,” the report said. “Ideally, fund companies would not use soft-dollar arrangements at all. But if they do, they should be disclosed and used on research that directly benefits the fund. Morningstar does not approve of soft dollars being used to offset fund management expenses, pay entertainment costs and so forth.”
Another downside is that investors cannot buy funds outside of the United States, which Morningstar argues limits choice.
Also, unlike other countries, funds must distribute realized gains to shareholders on an annual basis for tax purposes.
Another criticism is that although registered investment advisors in the U.S. are acting under a fiduciary standard, many brokers are still operating under a lower suitability standard. The DOL rule has helped in that regard, requiring advisors to act in their clients’ best interests in retirement accounts. But part of that rule has been delayed until 2019.
“For the time being, though, some brokers are still allowed to sell higher-commission funds when a lower-cost alternative might be better for the investor,” the report said.
