Industry Chatter a Look Ahead at 2017

Financial Professional Content This year has been busy, with Wealthfront introducing the first 529 plan administered by a roboadvisor in Nevada, the turnover of the Rhode Island 529 plans previously administered by AllianceBernstein to Ascensus and Invesco, implementation of money market options in response to 2014 reforms and multiple new ABLE plan launches. With 2017 around the corner, the 529 industry faces hot topics of its own, and not just the perennial pressure to reduce fees. The Fiduciary Rule The financial services industry is still coming to grips with the new "Fiduciary Rule" that was introduced in April by the Department of Labor. The new rule modifies the "investment advice fiduciary" definition under the Employee Retirement Income Security Act of 1974 (ERISA). Any advisor that works with retirement plans will, under the new legislation, be bound to meet a fiduciary standard of service (i.e. recommending the best option vs. a "suitable" option). The new rules are phased-in starting April 10, 2017, but they have already had a substantial impact on every industry that is involved with financial products in some way. 529 plan providers will largely escape the immediate impact of the Fiduciary Rule. Many factors make fiduciary-like rules for 529 plans largely unnecessary, such as state tax benefits (which necessitate certain disclosures for out-of-state plan recommendations), existing oversight and annual investment reallocation restrictions. Still, the new rule is so massive that even the 529 space will receive some collateral damage. Namely, fees will go even lower. The Fiduciary Rule puts a lot of pressure on asset managers and intermediaries to offer low-cost options to meet investor goals. So while fees have already come down dramatically in 529 plans in the past 15 years due to competition within the industry, the underlying investments in the plans are likely to get even less expensive. This may result in some bargain hunting among those plan providers that have more wiggle-room to swap out underlying investments for cheaper options down the road. However, there may be less for 529 providers to choose from. All this pressure on fees and disclosure requirements is speculated to result in the exit of some asset managers from the business, as shelf-space for more expensive or more exotic products (often both) is eliminated so distributors can focus on a more select list of investment options. This could, separate the wheat from the chaff until only the best investments remain, but it may also result in limited options for college savers as new entrants become scarce (pricing pressure making it more difficult for startups to compete). There are certainly broader implications and possibilities resulting from the new rule, with speculations that one-fifth to one-half of advisors could leave the financial advisor industry in the wake of the rule, so expect this to be a hot topic in the 529 plan industry ï ¿ ½ really every financial services subcategory ï ¿ ½ this year. Related: How the Fiduciary Rule Impacts 529 plans Sales charges Fees, in general, continue to be the defining factor by which 529 plans are evaluated. Indeed, the DC College Savings Plan administered by Calvert has one of the best performance records of any 529 plan available, ranking in the top three among advisor-sold plans both with and without sales charges over one-, three-, five- and ten-year time periods, and performed similarly well among direct-sold plans despite its higher fees. Yet even with some of the best performance of any 529 plan, and being the only plan comprised almost entirely of socially-conscious investments, the plan was criticized for its high fees. Calvert is now being being removed in favor of Ascensus. All of the attention the Fiduciary Rule is putting on fees and disclosure is going to have a direct impact on sales charges in the 529 space. Following an industry trend, two advisor-sold 529 plans recently introduced share class structures that automatically convert from Class C to Class A under certain conditions, including the new iteration of the Rhode Island Collegebound Advisor-sold plan. Distributors have always been sensitive to appropriate sales of share classes, and with increased regulatory pressure, there has been an equivalent response from multiple advisory firms. Both wirehouses and independents have adopted policies and procedures preventing their representatives from opening Class C shares with beneficiaries under a certain age (typically 12 or 13). This not only limits the firmï ¿ ½s risk exposure to inappropriate recommendation suits from investors, but also results in providers modifying their product offerings to better appeal to distributor compliance officers. Automatic conversions of C-shares after a certain number of years is good for everyone involved, ensuring investors are in an appropriate share structure, and limiting risk to the provider and distributor. Some distributors are pushing plan providers to adopt this model either directly, by asking, or indirectly, by favoring sale of plans with the new share class structure. But itï ¿ ½s not just the C-share structure that is likely to fall under pressure. 529 plans that charge a higher sales load may also start to feel the heat from distributors. Itï ¿ ½s difficult to prove that a plan charging 5.75% is significantly better than one charging a load of 3.00% (or lower after breakpoints). It wouldnï ¿ ½t be surprising to see some plans start to reduce and/or simplify their commissions in response to this and other factors, including the need to remain competitive and the Fiduciary Rule itself. Omnibus Omnibus is not a new topic, and within the 529 industry a lot of people are sick of talking about it, but the discussion isnï ¿ ½t going to end anytime soon. Further, the industry is fast approaching an inflection point. As one wirehouse representative stated in the halls at the 529 Conference this year, "Weï ¿ ½ve already gone omni with most of the plans that are willing. Weï ¿ ½d like to have more plans go omni, but there just arenï ¿ ½t a lot left that either can or want to." In 2017 the discussions between the largest intermediaries and those 529 providers that havenï ¿ ½t yet gone omni is likely to go one of two ways: The distributor and plan need to go omnibus, and the distributors will pressure providers by limiting shelf space for their 529 products, or seek revenue share to offset costs associated with check & app processing (that said, distributors will seek compensation for going omnibus in the form of sub-TA fees, too). Or- Distributors and providers will look to alternative solutions to omnibus, affectionately labeled "omnibus-light" at the recent 529 Conference, in order to better service and support their advisors. There is also the possibility that the Fiduciary Rule monopolizes the legal and compliance resources of the big firms, making it nearly impossible to make any material headway in implementing either solution in the coming year. Related: Omnibus ï ¿ ½ What it is and why advisors should care Omnibus ï ¿ ½ Challenges to implementation Omnibus ï ¿ ½ Omnibus-light and the future Financial Professional Content This year has been busy, with Wealthfront introducing the first 529 plan administered by a roboadvisor in Nevada, the turnover of the Rhode Island 529 plans previously administered by AllianceBernstein to Ascensus and Invesco, implementation of money market options in response to 2014 reforms and multiple new ABLE plan launches. With 2017 around the corner, the 529 industry faces hot topics of its own, and not just the perennial pressure to reduce fees. The Fiduciary Rule The financial services industry is still coming to grips with the new "Fiduciary Rule" that was introduced in April by the Department of Labor. The new rule modifies the "investment advice fiduciary" definition under the Employee Retirement Income Security Act of 1974 (ERISA). Any advisor that works with retirement plans will, under the new legislation, be bound to meet a fiduciary standard of service (i.e. recommending the best option vs. a "suitable" option). The new rules are phased-in starting April 10, 2017, but they have already had a substantial impact on every industry that is involved with financial products in some way. 529 plan providers will largely escape the immediate impact of the Fiduciary Rule. Many factors make fiduciary-like rules for 529 plans largely unnecessary, such as state tax benefits (which necessitate certain disclosures for out-of-state plan recommendations), existing oversight and annual investment reallocation restrictions. Still, the new rule is so massive that even the 529 space will receive some collateral damage. Namely, fees will go even lower. The Fiduciary Rule puts a lot of pressure on asset managers and intermediaries to offer low-cost options to meet investor goals. So while fees have already come down dramatically in 529 plans in the past 15 years due to competition within the industry, the underlying investments in the plans are likely to get even less expensive. This may result in some bargain hunting among those plan providers that have more wiggle-room to swap out underlying investments for cheaper options down the road. However, there may be less for 529 providers to choose from. All this pressure on fees and disclosure requirements is speculated to result in the exit of some asset managers from the business, as shelf-space for more expensive or more exotic products (often both) is eliminated so distributors can focus on a more select list of investment options. This could, separate the wheat from the chaff until only the best investments remain, but it may also result in limited options for college savers as new entrants become scarce (pricing pressure making it more difficult for startups to compete). There are certainly broader implications and possibilities resulting from the new rule, with speculations that one-fifth to one-half of advisors could leave the financial advisor industry in the wake of the rule, so expect this to be a hot topic in the 529 plan industry ï ¿ ½ really every financial services subcategory ï ¿ ½ this year. Related: How the Fiduciary Rule Impacts 529 plans Sales charges Fees, in general, continue to be the defining factor by which 529 plans are evaluated. Indeed, the DC College Savings Plan administered by Calvert has one of the best performance records of any 529 plan available, ranking in the top three among advisor-sold plans both with and without sales charges over one-, three-, five- and ten-year time periods, and performed similarly well among direct-sold plans despite its higher fees. Yet even with some of the best performance of any 529 plan, and being the only plan comprised almost entirely of socially-conscious investments, the plan was criticized for its high fees. Calvert is now being being removed in favor of Ascensus. All of the attention the Fiduciary Rule is putting on fees and disclosure is going to have a direct impact on sales charges in the 529 space. Following an industry trend, two advisor-sold 529 plans recently introduced share class structures that automatically convert from Class C to Class A under certain conditions, including the new iteration of the Rhode Island Collegebound Advisor-sold plan. Distributors have always been sensitive to appropriate sales of share classes, and with increased regulatory pressure, there has been an equivalent response from multiple advisory firms. Both wirehouses and independents have adopted policies and procedures preventing their representatives from opening Class C shares with beneficiaries under a certain age (typically 12 or 13). This not only limits the firmï ¿ ½s risk exposure to inappropriate recommendation suits from investors, but also results in providers modifying their product offerings to better appeal to distributor compliance officers. Automatic conversions of C-shares after a certain number of years is good for everyone involved, ensuring investors are in an appropriate share structure, and limiting risk to the provider and distributor. Some distributors are pushing plan providers to adopt this model either directly, by asking, or indirectly, by favoring sale of plans with the new share class structure. But itï ¿ ½s not just the C-share structure that is likely to fall under pressure. 529 plans that charge a higher sales load may also start to feel the heat from distributors. Itï ¿ ½s difficult to prove that a plan charging 5.75% is significantly better than one charging a load of 3.00% (or lower after breakpoints). It wouldnï ¿ ½t be surprising to see some plans start to reduce and/or simplify their commissions in response to this and other factors, including the need to remain competitive and the Fiduciary Rule itself. Omnibus Omnibus is not a new topic, and within the 529 industry a lot of people are sick of talking about it, but the discussion isnï ¿ ½t going to end anytime soon. Further, the industry is fast approaching an inflection point. As one wirehouse representative stated in the halls at the 529 Conference this year, "Weï ¿ ½ve already gone omni with most of the plans that are willing. Weï ¿ ½d like to have more plans go omni, but there just arenï ¿ ½t a lot left that either can or want to." In 2017 the discussions between the largest intermediaries and those 529 providers that havenï ¿ ½t yet gone omni is likely to go one of two ways: The distributor and plan need to go omnibus, and the distributors will pressure providers by limiting shelf space for their 529 products, or seek revenue share to offset costs associated with check & app processing (that said, distributors will seek compensation for going omnibus in the form of sub-TA fees, too). Or- Distributors and providers will look to alternative solutions to omnibus, affectionately labeled "omnibus-light" at the recent 529 Conference, in order to better service and support their advisors. There is also the possibility that the Fiduciary Rule monopolizes the legal and compliance resources of the big firms, making it nearly impossible to make any material headway in implementing either solution in the coming year. Related: Omnibus ï ¿ ½ What it is and why advisors should care Omnibus ï ¿ ½ Challenges to implementation Omnibus ï ¿ ½ Omnibus-light and the future