SEC AMAC Meeting
Securities and Exchange Commission
Asset Management Advisory Committee (AMAC)
Wednesday, July 7, 2021
Welcome and Opening Remarks
Chair Gary Gensler
In his opening remarks, Gensler raised concerns around sustainability “advertising” and the growing number of funds that market themselves as green or sustainable. He said it is important to know what information stands behind the claims of a fund being green, noting that when it comes to sustainability investing, there is a wide range of what “green” might mean. Gensler stated that these sustainability labels influence investors and asked staff to consider recommendations on whether fund managers should disclosure the criteria and underlying data they use to meet that criteria. He said he has asked staff to take a holistic look at naming conventions, noting that a fund name is one of the first pieces of information an investor sees. Gensler said he has also asked staff whether the distinction between investment type or strategy is still relevant today. He concluded his Environmental, Social, and Governance (ESG) comments in saying updates to funding disclosure and naming conventions could bring much needed transparency. Gensler turned to the Diversity and Inclusion (D&I) recommendations, and stated the asset management industry has much work to do to increase racial and gender diversity. He said he has asked staff to consider ways to enhance transparency through requiring disclosure of aggregate demographic information, as well as advisors’ diversity and inclusion practices and the selection of other advisors.
Commissioner Hester Pierce
In her opening remarks, Pierce began by applauding technology-enabled personalization for offering the asset management industry a powerful new tool to serve investors better. Pierce urged the Committee to consider how differences between financial reporting and ESG reporting could make ESG efforts unworkable in the future. She said concrete steps can be taken to educate the youth and rethink criteria in hiring professional financial managers. She expressed her concerns about the “pay-to-play” recommendations and said they need to think carefully about a government mandated diversity classification toward the asset management industry, arguing it may not promote the unity they want. Pierce said she hopes the Commission will think through practical issues that would arise if such mandates were adopted to define diversity, and how the Commission can verify the accuracy of firms’ D&I statements, and what consequences should be in place if they are proven to be inaccurate.
Commissioner Elad Roisman
In his opening remarks, Roisman applauded the Committee’s approach to making these recommendations as having been methodical, iterative, and transparent. He said he is confident that each recommendation will help inform staff to consider new approaches to the market issues that have been identified.
Commissioner Allison Herren Lee
In her opening remarks, Lee said she was deeply impressed by the D&I Subcommittee and the seriousness with which they explored the lack of diversity in the asset management community. She said she looks forward to thoughtful discussion of the Commission’s role in promoting greater transparency and ensuring disclosure rules promote public interest. Lee also said she looks forward to discussing the ESG Subcommittee recommendations relating to issuer disclosure and the regulation of funds and other investment products that pursue an ESG strategy. Relating to issuer disclosures, Lee said there is a broad consensus that any regime must provide consistent and reliable information, noting that currently, issuer disclosure occurs on an ad hoc basis. Lee also expressed concerns in adopting a third-party ESG disclosure framework, arguing it will not address the core inadequacies.
Commissioner Caroline Crenshaw
In her opening remarks, Crenshaw said she is pleased to see the agenda include final recommendations from the D&I and ESG subcommittees, noting their work is important and timely. She said the data on lack of D&I is startling and makes a compelling case for action. She cited from their report that one percent of nearly 70 trillion in global asset management are managed by women or minority owned firms, highlighting their dramatic underrepresentation. Crenshaw said the Commission has a role to play in promoting greater diversity and inclusion and is interested to hear about guidance that could discourage discrimination by fiduciaries. Turning to the ESG recommendations, Crenshaw said she agrees there is an undeniable demand for ESG oriented investments and disclosures and individuals are using ESG related metrics to make investment decisions and to allocate capital more than ever before. However, Crenshaw’s only reservation with ESG recommendations was how to ensure ESG disclosures are consistent and comparable. Turning to the tech-enabled advice panel, Crenshaw said she would like to understand how personalization helps or changes the definition of investment advice, what incentives are at play for entities rendering tech-enabled personalization, and why more investors are starting to turn to these products.
Subcommittee Updates and Recommendations
Recommendations of the Diversity and Inclusion Subcommittee
Gilbert Garcia, Chair of the Subcommittee, urged the Commission to look at D&I not as an item, but as a core value that permeates everything of the SEC. Scott Draeger explained the focus of their mission and highlighted key insights learned from their studies. He said they gained a perspective on investor interest, considered investors need for D&I transparency, and considered whether Commission action would benefit the industry at large.
Draeger said the statistics were startling, citing that of the $70 trillion in global financial assets under management across the investment universe, less than one percent are managed by minority-owned or women-owned firms. Draeger noted their data showed that active discrimination exists and remains a barrier for minority- and women-owned firms. He said performance myths were dispelled, as they found evidence that investment performance by diverse asset managers was equal to or greater than the investment performance of firms that lack diversity in ownership and senior leadership. Draeger noted the evolution of public interest and materiality and the increase in demand for transparency on D&I efforts in the industry.
The Subcommittee presented four sets of recommendations. The first set included three enhanced disclosure requirements within SEC filings under Form ADV and Form N-1A to promote transparency of (1) the diversity within a firm, (2) fund board and fund adviser diversity, and (3) business practices for consultants who recommend investment advisers and investment funds.
The second recommendation was to issue Commission or staff guidance to fiduciaries in their selection of asset managers. Draeger said many fiduciaries use a narrow checklist of exclusionary factors, such as AUM and length of performance track record, which have a highly discriminatory indirect or direct impact of eliminating nearly all firms owned by women and people of color. As such, he said the industry would benefit from Commission guidance that clarifies a wide variety of factors may be considered by fiduciaries in their selection of asset management firms.
The third recommendation was to conduct an SEC staff study to look at “pay-to-play” and the influence of political contributions on asset allocation in the institutional market. Draeger said investment advisers should be prohibited from making political contributions which may inappropriately influence the award of investment advisory contracts. He urged the Commission to study whether the limitations of the pay-to-play rules allow for contributions to be made by market participants with large PACs and lobbying budgets, which are funded by, and typically used to procure influence for, disproportionately large, non-diverse firms.
The fourth and final recommendation was to require a procedure for the management of reports on discriminatory practices. Draeger said the Commission should establish centralized and uniform practices for directing reporting parties to an office at an agency equipped to investigate valid complaints, and maintain records associated with complaints so they can be monitored and evaluated over time.
The Commission voted to adopt these recommendations in their entirety.
Recommendations of the ESG Subcommittee
Aye Soe, S&P Dow Jones Indices, stated that issuer disclosure is the starting point for ESG matters, particularly comparability and consistency of ESG disclosures. She added that as ESG investment products proliferate and large amounts of capital flows into those products, there is a need for alignment of ESG products with corresponding terminology.
Jeffrey Ptak, Morningstar Research Services, presented the rationale behind the committee’s recommendations, noting that best practices for ESG are still being debated and that the SEC ought to consider the significance that investors have come to attach to ESG. He stated three reasons for investors making ESG a focus, including performance, market interest, and regulatory activity and professional standards.
The AMAC concluded that it was premature to recommend specific mandated disclosure of material ESG matters through SEC rulemaking or through third-party standards and that the SEC should provide principles-based guidance after consistent and comparable ESG metrics have become widely adopted and accepted. The AMAC recommended as best practice that ESG products describe their objectives and how they prioritize them and also recommended the adoption of the terminology developed by the Investment Companies Institute (ICI) ESG Working Group.
For issuer disclosure, the AMAC recommended that the SEC foster meaningful, consistent, and comparable ESG disclosure by encouraging issuers to adopt an ESG disclosure framework and provide an explanation if no framework is adopted. The AMAC also recommended that the SEC accelerate its third-party ESG disclosure framework study and gather subject matter expertise on the issue.
For investment product disclosure, the AMAC recommended that the SEC suggest best practices for ESG investment product disclosure and for investment products to describe each product’s planned approach to share ownership activities and notable recent ownership activities outside proxy voting.
On performance management, the AMAC found that there is not yet a clear picture of the impact of ESG on performance and that there is no finding that ESG should be treated differently than other fund objectives or strategies with respect to disclosing performance. As data and ESG investing practices improve, performance measurement and other analyses may become for valuable.
The panel voted to adopt recommendations for the SEC to encourage companies to provide information on ESG matters.
Update from the Private Investments Subcommittee and Discussion of Potential Recommendations
The Subcommittee began their discussion focusing on the Asset Management and Registered Investment Company (RIC) landscape, citing that the Asset Management industry has grown faster than either inflation or GDP, at around 5.5 percent compounded growth, compared to 2 and 2.2 percent for GDP and inflation. They additionally stated that the number of mutual funds has stayed relatively flat, with around 9000 funds at the end of 2020, while ETFs have grown explosively over the same period, from around 200 funds managing $0.3 trillion in 2005 to around 2020 funds managing $5.1 trillion in 2020. They also noted that retail investors and self-directed retirement assets have become an increasingly larger part of the overall AUM and stated that there is a growing asset management industry, with underlying exposure through mutual fund and ETFs largely due to US equity markets.
The subcommittee concluded that there is a growing demand for investment choice from all investors, including retail investors as the asset management industry grows more quickly than GDP and inflation. They noted that while there is arguably a greater choice for retail investors in terms of tailoring exposure particularly via ETFs, exposure is still primarily to the underlying U.S. public equity markets. In turn, this market has grown increasingly concentrated with fewer listed companies and a higher concentration of large tech companies dominating market capitalization weighted indices such as S&P 500 and NASDAQ-100.
In the Subcommittee’s discussion of private equity, they concluded that private equity funds have the potential to offer return and diversification benefits to retail investors, but that the difficulty in measuring and reporting returns on a comparable basis, coupled with the potentially higher fees associated with private equity investments, are important considerations in the decision of whether to expand retail access to pooled private equity investments.
In the discussion of private debt, they found that funds appear to outperform public debt indices over medium and longer horizons, but that over horizons less than 3 years, private debt funds underperform public indices.
In discussing current access to private investments by retail investors, the Subcommittee recognized that open-end mutual funds are subject to a general 15 percent threshold on acquiring illiquid investments, and that closed-end funds have limited their offerings to Accredited Investors, pursuant to the SEC’s Division of Investment Management concerns around investor protection.
The Subcommittee stated that broad access to private investments is currently not available to retail investors via existing investment vehicles. The Subcommittee continued by stating that access to investments for non-retail investors is primarily via “qualification” thresholds including the Accredited Investor, the Qualified Client, and the Qualified Purchaser. They noted that with the current regulatory landscape, most retail investors are precluded from the majority of private investments. In particular, the very high financial threshold for Qualified Purchasers makes access to diversified 3(c)(7) private funds virtually impossible for most retail investors.
The Subcommittee’s overall conclusions were that the returns of private investments that were examined were not easily comparable to public markets and that the subcommittee finds support for the returns being at least lightly to somewhat better than comparable public market investments. Second, they found private investments also offer diversification benefits to retail investment portfolios and private fund managers tend to exhibit higher dispersion in their returns compared to public fund managers. Finally, they argued the current legal and regulatory framework is such that while there are some retail investment vehicles that can invest in private investments, these make up a small portion of the AUM in registered investment companies. Given these conclusions, the subcommittee recommended widening retail investor access to private investments subject to appropriate “Design Principles” that strike a balance between wider access and investor protection.
The suggested Design Principles had four components, all seeking to balance investor choice, needs, and protection for any policy recommendations.
The first principle was liquidity. They said direct private investments often involve no secondary market liquidity and few, if any, redemption rights. They suggested that investment structures offering at least limited redemption rights or secondary market trading ought to be encouraged.
The second principle was chaperoned access. They said retail investors require an additional level of protection in accessing private investments, which may be achieved via chaperoned access through various methods including using the RIC framework (with some modifications) or allowing retail investments only in funds with significant large institutional investors participation.
The third was diversification. They stated that diversification through a portfolio of investments in different private funds (or a private fund of funds) can help reduce potential performance dispersion and volatility that may occur with more concentrated private investments. In addition, they said retail investors should consider private investments in the context of a diversified overall portfolio that includes more liquid investment. However, they said mandating or even monitoring overall portfolio diversification may not be feasible.
The fourth and final principle was disclosure. They said access to private investments must include standardized disclosure of important information, particularly with respect to performance, risks, and fees.
Presentations
Evolution of Advice: Technology-Enabled Personalization
Participants:
- AMAC Panel Moderator: Mike Durbin, Fidelity Institutional
- Ed O’Brien, eMoney Advisor LLC
- Jay Lipman, Ethic
- Dan Egan, Betterment
- Michael Kitces, Kitces.com
In his opening remarks, Mike Durbin, Fidelity Institutional, provided context for the establishment of the Committee. He stated that the Committee explores technological advancements that have allowed for personalized investment and a broad range of investment tools. He outlined that the panel would explore what these personalized tools offer, what the implications are for the destination of investment advice, the role advisors play in this process, and if there are any emerging opportunities that allow for better investors protection. He highlighted four considerations for the panelists. The first was how the level of personalization impacts whether it is defined as investment advice. The second was the risks or opportunities associated with artificial intelligence or machine learning that drive personalization. The third was whether increased access to an investors personal information changes the level of responsibility the advisor has when offering a recommendation. Finally, Durbin said the Committee should consider how the trend toward personalization impacts investor’s ability to understand and evaluate the investment advice they receive.
In his presentation, Ed O’Brien, eMoney Advisor, said financial planning technology can help deliver more dynamic financial plans and generate better returns for customers and that technology also helps automate the commodity part of financial planning, such as analysis and what-if scenarios processing, as well as give advisors more time to engage with and understand their clients. He said the supply of financial advisors in the U.S. has remained flat, but demand has continued to grow over the past years. He said the creation of financial planning software can help get financial planning advice to 50 million more households, and quicker, as it simplifies the process. O’Brien explained the process of comprehensive financial planning as: 1) assemble client’s full financial picture; 2) engage clients with financial tools and professional experiences; 3) leverage what-if scenarios in drive deeper understanding; and 4) deliver a personalized financial plan. O’Brien stressed that building transparency is key in financial planning. O’Brien presented a survey that shows how technology is driving advisor efficiency and client satisfaction. He explained that with the technology, clients can quickly update financial plans to process what-if scenarios, improving efficiency. The survey also showed that clients are excited to engage with technology to process what-if scenarios that these software platforms offer.
In his presentation, Jay Lipman, Ethic, focused on the risks and opportunities associated with the personalization of investment, explaining that risk increases with more personalization. He stated that investor expectations are rapidly growing and delivering a personalized offering is now an essential service. Lipman described how technology could power efficiency and scale throughout the lifecycle of investment personalization and identified six steps where wealth and asset management merge in the personalized investing process, concluding that wealth management is a passive equity exposure that reflects the information in the process. He laid out five controls that technology and data science provide: transparency, auditability, interpretability, scalability, and adaptability. He concluded by posing five considerations for personalized investing when technology is used throughout the investment lifecycle. These included: (1) the consideration of what new applications of data or standards should be considered as more personal data (social) becomes publicly available, (2) what detail or types of information investors would find most useful in assessing and comparing personalized investments, (3) how investors will be able to assess their personalized choices over time, (4) how regulators can promote transparency in the creation of personalized investment portfolios without stifling innovation, and (5) what reporting asset managers might use for personalized investment products that differs from other investments.
In his presentation, Michael Kitces, Kitces.com, provided an overview of industry trends that are reshaping financial advice. He explained that technology is commoditizing financial advisors once again and that we are at a crossroads to examine how technology and financial advice fits into the financial advisor space. He highlighted that the advancements in technology have created a convergence crisis of differentiation as the search for new models in the client experience persists. He concluded that there are regulatory issues involved with the introduction of robots into this space as they begin to take the jobs of humans.
Q&A
Jane Carten, Saturna Capital, asked how financial planning is important for lower income individuals and how technology helps. O’Brien said it is critical for lower net worth individuals to have access to financial and retirement planning. He added that making the right decisions early in life is important for retirement and weathering economic downturns. He said technology enables people to make the right, tailored financial decisions and plans more easily. Carten said many individuals saw high returns in 2020 and asked if it is due to the help of technology or the overall sentiment of the market. O’Brien said they do see a distinctive difference between clients with and without financial plans, so expanding financial planning to more clients is important for lower net worth individuals.
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