The U.S. retirement income industry is a complex beast with income derived from many sources, like Social Security, traditional pensions, 401(k)s, and Individual Retirement Accounts.
Managing an IRA can be a hard task for individuals, as they involve many possible products. This leads people to seek professional advice. With commission-based compensation and complex fees, conflicts of interest are commonplace.
A report by the The Council of Economic Advisers estimated that the annual cost of conflicted advice is about $17 billion each year, with $1.7 trillion of IRA assets invested in products with conflicts of interest.
It is on this backdrop that the DoL released a new set of rules requiring anyone providing investment advice to retirement plans to do so under fiduciary requirements to be prudent and avoid conflict of interest. The industry is now scrambling to change products, workflows and fee structures to comply with the new rules before the effective date of April 10, 2017.
With compliance costs high, many advisors are exiting the business. Other are restructuring their compensation structure. Cambridge Investment Research, an independent broker dealer, estimates that it will spend $15 million to $17 million on technology upgrades and other operational changes in anticipation of the rule.
With higher compliance costs, some are looking to cheaper options, like roboadvisors, to offer scalable solutions.
“Since roboadvisors charge a flat fee, many believe that they will comply with the DOL fiduciary rule without the need to justify fees or show that there is no conflict of interest under the Best Interest Contract Exemption,” wrote Bates Research Groups. Technology firm, CGI suggested roboadvisors will be used to service accounts that otherwise would be deemed not profitable enough and might be orphaned.
However, the question whether roboadvisors themselves can themselves be considered fiduciary is debatable.
Earlier this year the Massachusetts Securities Division issued a policy statement that examined roboadvisor compliance with their fiduciary responsibility. The policy statement questioned software’s ability to take a client’s personal situation into account when issuing advice and conducting proper due diligence.
“The commoditization of advice and streamlining of solutions, based on few broad initial survey questions, lends itself to ‘one-size-fits-many’ portfolios that may not be suitable for each client,” commented Min Zhang, CEO of Totum Wealth, a provider of technology solutions to advisors. The way roboadvisors are structured, she added, lures clients into a potential false sense of confidence that something truly unique is being created for them.
Blaine Aikin, executive chairman at fi360, which offers fiduciary education, certifications, software and practice management offerings, echoed Zhang’s sentiment. Roboadvisors do a good job for people with simple and well-defined goals, he said. Problems arise when cases become more complex, though. Roboadvisors currently do not really personalize their offerings, which might be a breach of due care responsibility.
In addition, algorithms might have systemic biases, which might prevent them from offering advice that is truly in the best interest of their clients.
Both Zhang and Aikin agree technology and roboadvisors will play an increasing role in the future of wealth management, but envision more of a hybrid model, where robos support humans to make better decisions, but the humans have their hands on the wheel.
There is no overarching regulation regarding roboadvisors. FINRA, the SEC and the DoL are dealing with aspects of automated investments advice. It is mostly up to advisors to figure out how to comply with the ever-changing regulatory landscape.