Morningstar - Q4 2020 - 14

Dispatches

past 75 years has inflation seriously threatened
U.S. investments, and when it did, cash
acquitted itself fairly well. As inflation spiked,
Treasury-bill rates followed suit, reaching
as high as 15%. Cash is light on its feet. If market
rates change dramatically, cash reacts
quickly, while rival investments are hobbled by
their longer durations.
Further Considerations
I have two caveats. One is that tangible assets-
commodities such as gold, energy futures,
and real estate-will likely outgain cash
should inflation return. I recommended such
investments only half-heartedly because
they are often illiquid and almost always volatile.
Unlike cash, however, they have the potential to
score significant profits after inflation.

rising inflation in customary fashion, by raising
short-term rates. That would be good for
cash returns.
However, I realize that many readers do not share
my faith that the U.S. government will treat
its creditors so graciously. They foresee the U.S.
implicitly shirking its debt obligation by keeping
rates relatively low, as it did before. Such
skeptics will prefer tangible assets and perhaps
even equities. K
John Rekenthaler is a vice president with Morningstar
Research Services. He is quick to point out that the views
expressed in Ivory Towers are his own.

The other is the possibility that the Federal
Reserve repeats its World War II policy.
When prices surged-more than 9% in each of
1941 and 1942, and then a shocking 18% in
1946-the Fed surrendered. Rather than fight
the trend, it kept short-term interest rates
at the very low level of 0.375%, thereby assisting
the war effort by inflating away much
of the country's debt. Unsurprisingly, cash
performed terribly.

Another Fiduciary Rule?
A new DOL proposal
increases confusion.

World War II: The Fed Capitulates From
January 1941 through December 1947,
inflation averaged 7.8%.

This summer, the U.S. Department of Labor
proposed another fiduciary rule, replacing the one
it finalized in 2016 that was soon vacated
by the U.S. Court of Appeals for the 5th Circuit. This
now marks a decade of back-and-forth proposals
and rules from the DOL and the Securities
and Exchange Commission aiming to raise
standards for advisors. This latest proposal mostly
maintains the new standard of conduct
for advisors, but if it is finalized as written, there
are details investors and advisors need to know.

Annualized Real Return (%)

Cash

-7.5

Intermediate-Term Bonds

-6.3

Long-Term Bonds

-5.6

Large-Cap Stocks

2.7

Source: Morningstar Direct.

Should inflation return, I do not think today's
Federal Reserve will act similarly. The
memory of the 1960s and 1970s still lurks in
central bankers' minds. Also, economic
decisions made during peacetime differ from
those made during total war. For those
reasons, I believe the Fed would respond to

14

Morningstar Q4 2020

POLICY

Aron Szapiro

In addition to proposing a rule, the DOL made
two other significant changes to guidance
and regulation that take immediate effect. An old
"five-part" test-originally created in 1975-
was restored to determine who is and is not a
fiduciary under the Employee Retirement Income
Security Act, which governs most privatesector tax-privileged retirement accounts. This

test is at the heart of the ongoing fight over
which financial professionals must put their clients'
needs first and which ones can act more
as salespeople. The DOL also changed some key
guidance on whether a rollover recommendation
counts as investment advice: It now counts
and could be subject to the new fiduciary rules.
Fewer Advisors Will Be Fiduciaries

Under the restored five-part test, brokers
giving financial advice to retirement savers often
will not qualify as fiduciaries if they do not
regularly give advice. Insurance agents who sell
annuities on a one-time basis probably will
never qualify. In contrast, the 2016 proposal would
have increased the number of financial
professionals operating as legal fiduciaries when
offering advice to people who are saving for
retirement in IRAs and 401(k)s, as well as in other
ERISA-covered investment accounts.
Our view is that when financial professionals
give advice to people saving for retirement,
even if it is not on a regular basis, they should put
investors' interests first. Conflicted advice has
been linked to millions of Americans rolling over
low-cost 401(k) accounts into higher-cost IRAs
and investing in funds with higher expense
ratios and loads. At a minimum, financial advisors
should be required to analyze rollover
recommendations to ensure they are beneficial
for the client.
Justifying Rollovers
In 2004, the DOL took the position that rollover

advice was not a recommendation. Now,
it depends on whether that advice is part of an
ongoing relationship or, under the DOL's
interpretative statement, whether it could be the
beginning of an ongoing relationship. The rule
also requires that advisors who qualify as
fiduciaries analyze and document the reasons for
the rollover. For some investors, this could be
good news. Advice to participants in 401(k) plans
is held to a high legal standard, and these plans
often offer a high-quality, low-cost investment
lineup. While we don't expect this rule to reduce
the flow of assets from 401(k) plans to IRAs,
it will help retirement savers see what value their
advisors are offering and require advisors to offer
value for the fees they charge to justify the rollover.
Morningstar - Q4 2020

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