The U.S. Department of Labor could be heading down a perilous path with its planned rules changes that may directly impact the average investor, making retirement more complicated and financial advice less accessible.
In a nutshell, the DOL’s proposed changes to the definition of “investment advice” could create ambiguity around when a fiduciary relationship begins and even more alarming could establish a class of “preferred” investment choices. But in an Administration that prides itself on regulations, it’s what is not regulated that concerns me.
The federal government has mandated that passive, or index-style, investments should get favorable treatment and be excluded from the regulations. Not only am I concerned that the federal government is attempting to provide investment advice of its own but it is simply bad advice to send a message to consumers that a single investment style is better or safer under a variety of circumstances.
Proper investing is not an all-or-nothing proposition. A truly durable portfolio is built with an understanding of how to effectively incorporate passive and active strategies, because over time and with changing market conditions, there are advantages to both. In fact, results we are beginning to announce from a global survey show that each approach plays a specific role within client portfolios. Globally, advisors report their portfolios are composed of 65% active investments and 35% passive. [1]
So, creating a rule that steers investors to only one investment approach creates portfolio risk and hinders the ability to manage a portfolio through turbulent and changing markets.
Passive funds generally track an index or a basket of companies. After purchasing these indexes, investors hold the market and take the returns the market offers – both good and bad. But, some investors may not have the risk tolerance for this strategy alone.
For example, while an S&P 500 ® index fund is an inexpensive way to get exposure to this market, some investors may not have the stomach to handle the volatility of the S&P 500. In the past 10 years, the S&P has seen daily gains as high as 11.6% and daily losses as low as 9.0%.[2] Fiduciaries may conclude it isn’t prudent to hold the market. Certain actively managed mutual funds are designed to reduce volatility, which can help keep an investor in the market and increase the likelihood of meeting their long-term objectives.
While the fees for passive investment strategies are often lower, the idea that passive investing is inherently better for investors is flawed. Market conditions vary over time, and no single asset class or investment style is best for all markets. The performance of passive strategies is not systematically better than active strategies. And passive investing alone often does not provide adequate risk management to an overall portfolio.
Active managers try to produce returns in excess of the market indexes. They choose individual securities they believe can outperform a relevant benchmark. Active management has been proven to work better than passive indexing in certain asset classes and over certain periods of time. In particular, we have seen this in the smaller caps, international and emerging market funds and in many areas of the bond market.
Active management typically requires higher fees than passive management, but these higher fees are designed to buy the investor a certain level of expertise and market savvy.
A more effective approach for an investor is to achieve the appropriate balance between active and passively managed strategies by creating a durable portfolio that is diversified and focused on risk management. This approach to investing is designed to help investors weather volatility and to reward the patient investor who is focused on long-term goals.
The DOL needs to carefully and thoroughly think through the proposed rule change before it is finalized to prevent confusion amongst advisers and investors and to prevent giving blanketed advise to an entire industry. If they don’t, the consequences could directly impact the average Americans retirement strategy.
John Hailer is President and Chief Executive Officer for Natixis Global Asset Management
[1] Natixis’ 2015 Financial Advisor Survey was conducted in June 2015 with responses from 2,400 advisors in 14 different countries in Asia, Europe, Latin America, the United Kingdom and the Americas.
[2] Bloomberg, 2015.
