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Department of Labor (DOL) Fiduciary Rule: Counterintuitive Reaction or True Investor Protection?

February 8, 2016

by Jared Schneider (Managing Partner) | Blue Vault

One of the hottest topics right now in the alternative investments space is the DOL’s Fiduciary Rule legislation. The rule is designed to redefine what it means to be a fiduciary and how that affects retirement accounts (i.e., IRAs, 401ks, etc.). The rule stipulates that certain investments and commissions for those products are no longer allowed. For example, the rule, as it’s currently worded, would prohibit nontraded REITs, nontraded BDCs, private equity funds, hedge funds, and other alternatives from retirement accounts.

The outcome of the rule, however, contradicts our country’s general desire to encourage public participation in investments. For example, the recently passed JOBS Act was created to encourage entrepreneurship and job creation, and the ability for everyday investors to participate in these endeavors. But now, we have a rule stating that if that investment is part of your retirement account, you cannot invest in those types of opportunities. In the past couple of years, we’ve seen crowdfunding and general solicitation of private offerings become legal, but at the same time regulators were working on a way to discourage investors’ access to those very same investments.

Now, this is not to say there is no fault to be placed on the misconduct of bad brokers and fund sponsors. Additionally, the nontraded product and private fund space has lagged behind the rest of the investment world when it comes to transparency. Commissions and fees have driven up the cost of ownership for these investments, and many investors were unaware of the fees associated with them. Even so, as a whole, these nontraded products have provided very good returns to their investors. Blue Vault, in collaboration with the University of Georgia, has a study1 on the performance of all nontraded REITs that have gone full-cycle or provided liquidity to investors.

If the regulators’ goal is to expose and reduce commissions and fees, then by all means, do that. But rather than prohibiting investors from the ability to invest in alternatives, a much simpler solution would be to limit commissions and provide more transparency in reporting them. When this happened years ago in the mutual fund industry, assets under management grew after commissions came down and many no-load products were introduced. If fees and commissions are simply reduced, there is a strong argument that the masses would embrace and adopt nontraded funds and private funds.

The DOL Fiduciary Rule, while having good intentions of limiting conflicts of interest, has the unintended consequence of limiting access to investments. After all, access to the broadest range of asset classes and investment types should provide the best opportunity to diversify and mitigate risk. That is what a financial advisor wants to help clients accomplish for their portfolios.

1If you are not a Blue Vault Subscriber and would like a sample of the 4th Edition Nontraded REIT Full-Cycle Performance Study, click here.

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