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The Lower Cost Share Conversion

One of the major trends we’ve seen this year is firms with model portfolios doing massive conversions to lower cost shares. From regulation to current investor demand for lower fees, there are a number of factors that continue to shape this trend that is transforming the market.

The fiduciary rule’s impact:

The Department of Labor’s fiduciary rule is spurring many companies to convert to lower cost shares, which is ultimately beneficial to the many investors who increasingly want lower fees in their investments. The fiduciary rule was designed to reduce conflicts of interest and focuses on sales commissions and other fees, which is pushing firms to look for or create lower fee funds to comply with the rule. Even with a fiduciary rule delay going into effect, many firms are continuing to convert to lower cost shares. [1]

Transformations in firms and offerings:

This move to lower cost shares is shifting the fee pressure away from the asset managers – who have already felt margin pressure from competing with low fee passive investments – to the distributors and custodians. This switch has even caused some of the largest benchmark issuers of exchange-traded funds (ETFs) to lose business to new, cheaper index providers or firms bringing it in-house. [2]

As more advising firms convert to lower cost shares, the move should result in a consolidation of the number of share classes and the lineup of strategies offered. Companies like Wells Fargo Advisors and Ameriprise Financial are already taking steps to change the lineup of funds that advisors can use as the lowest share class as they place limits on mutual fund share classes and cut down on investment products, respectively. [3] Additionally, we have seen some firms even start to hire full-time employees to do just share conversions to lower cost share classes.

Future of lower cost shares:

Something firms should keep in mind when considering these changes is the recent Tibble versus Edison case, as it will have an impact on how firms make share-class changes. Tibble versus Edison is a case where investors said Edison International Inc. 401 (k) violated their duties as a fiduciary by picking more expensive retail-priced shares over lower-priced institutional shares. The judge in the case said that fiduciaries should switch share classes immediately if share classes are identical at lower costs. However, the judge did also note that lower-cost institutional shares aren’t always the best option for a plan. [4]

Firms that claim this shift to lower cost shares is just a fad may be disappointed. Investors are seeking out lower cost investment vehicles like ETFs and mutual funds, and their appetite for the lower cost vehicles doesn’t appear to be slowing. ETFs and passive investing continue to gain inflows, and after the first seven months of this year, investors had already broken last year’s record ETF inflow with $391 billion invested in ETFs. [5] If firms and investors continue to pursue lower cost shares, the conversion may not be just a trend – it could be an evolution of the investment industry.

Author’s disclaimer: The opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities, or investment advice or a recommended course of action in any given situation. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. Information obtained from third party resources are believed to be reliable but not guaranteed. This paper may contain ‘forward-looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader.

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