Tuesday, October 21, 2014

On the stability of Risk Tolerance

It is widely believed that (financial) risk tolerance is highly unstable and particularly subject to market conditions. However, through a series of independent studies there is now strong evidence that this view is incorrect. The most recent study clearly demonstrates the stability of risk tolerance across the 2003 to 2009 market rises and falls through detailed analysis of test/retest data, involving two tests of the same individuals, the first during the 2003-7 bull market and the second in the subsequent bear market. The study confirms the anecdotal evidence from FinaMetrica subscribers that clients' risk tolerance scores remained remarkably stable through the most turbulent market conditions in living memory. Many advisors and others involved in financial advisory services will now need to change their views about the nature of risk tolerance, how it should be assessed and its role in the financial advising process - all of which will be discussed under Consequences for Advice. However, before considering the consequences we should review the evidence for the stability of risk tolerance and before that we should examine why the contrary view is so widespread.Read the Research paper here

Monday, October 13, 2014

All you ever wanted to know about Disclosure...and MORE


A core tenet in contemporary securities regulation is that public disclosure will level the playing field by reducing information asymmetries. It's tempting to think that just by spelling out the features and risks on a piece of paper, let investors read it and everything's OK — the investor now can make an informed investment decision.. The reality is that the disclosure process is far more complex . Effective disclosure depends on how clearly written the disclosure is , the completeness of the disclosure, the investors' willingness to read it , the investor's understanding of the disclosure , the investor's financial and contractual literacy , the investor's vulnerability level, when the disclosure takes place and a number of other factors.Even the method of delivery ,font size and location can impact the effectiveness of disclosure.In the case of retail investors, we have concluded that disclosure is a necessary but insufficient tool for investor protection.In this blog we discuss a few key aspects of disclosure for the retail investor.

Take a look at our Comment letter on Point- Of- Sale disclosure to the Bank of International Settlements.It's a great primer on disclosure as it appies to investing. It's written in plain language so very easy to follow.http://www.bis.org/publ/joint32/kenmar.pdf

For over a decade, Kenmar Associates has advocated for the delivery of Fund Facts prior to the
decision to purchase mutual funds. For whatever reasons, such an obvious requirement has been
opposed by industry participants and lobbyists. This makes absolutely no sense if there is to be an
informed investment decision. It is inconceivable that an industry which constantly claims the value of investment advice should not insist that dealer representatives provide a copy of FF's to clients before the purchase decision is made. Providing FF two business days after the investment decision has been made is a nonsense disclosure . Here's what we told regulators http://www.osc.gov.on.ca/documents/en/Securities-Category8-Comments/com_20140411_81-101_kenmar-associates.pdf

Disclosure isn't just about product characteristics and features.One of the complaints often heard about the investment industry is lack of disclosure about compensation. It is up to clients to ask their financial advisor how they are compensated, and even then it might be difficult to verify if the advisor is telling the truth. Independent research has demonstrated that compensation has a huge impact on the investment recommendations by advisors ( non-fiduciaries). It would seem that more disclosure is the obvious answer, but according to one academic study it might not make much of a difference in the actions of clients and might make the advisors even more biased.George Loewenstein et al from Carnegie Mellon University wanted to evaluate the effects of conflict of interests disclosure from advisors, on the decision making of their clients. The study entitled “TheDirt On Coming Clean:Perverse Effects of Disclosing Conflicts of Interest“ had a surprising result .- disclosing the conflict- of- interest actually increased the bias even more.Lowenstein argues that “moral licensing” is one of the reasons this happens. Basically this theory says that an advisor with an undisclosed conflict- of-interest will feel guilty enough about it that they will try to “do the right thing” to some degree. By disclosing the conflict- of-interest, it allows the advisor to do whatever they want since they have admitted the conflict and therefore don’t have to feel guilty about it anymore. Be aware.

Regulators recognize that sales communications play an important role in the business of investment fund issuers, and as such,expect such communications to provide “clear, accurate and balanced messages, particularly when directed at retail investors.Such materials, if improperly written, can undo the positive intent of mandated disclosures.Sales communications should be in plain language and avoid the use of industry jargon, defined terms or acronyms and generally be easy to understand by retail investors. Information, including warnings, disclaimers and qualifications, must be given sufficient prominence in order to be consistent with the content of the document.Sales communications should not include statements that are vague or exaggerated or that cannot otherwise be verified. Regulators expect fund companies and dealers to include specific information in sales communication documentss if a distribution or yield is quantified in such document, including the basis of the calculation, the percentage of total distributions comprising reinvested units, how the yield was calculated, the time period covered by the distributions, the key assumptions and the impact changes to such key assumptions may have on the target distribution or yield. Lastly, They also expect that return of capital distributions should not be presented in a way to suggest that they represent investment returns.A lot of expectations but unfortunately little monitoring and regulatory enforcement.

It is all well and fine to disclose the MER of a mutual fund but unless the investor can assess the long-term impact on fees, the disclosure has limited value.Similarly ,if performance is provided without comparison to a benchmark , the average retail investor may derive little from the disclosure. Some disclosure documents are so complex and filled with elaborate terms and conditions that it should come as no surprise that retail investors find it difficult to make informed decisions.This is one reason why we have promoted the idea that investment advisors should be proficient and be required to act as fiduciaries.

We will soon be commenting on the fee and performance disclosures required by the Client Relationship Model part 2.Until CRM2 disclosure focussed on the prospectus and continuous disclosure obligations. With CRM2 ,regulators awoke to the fact that dealers had been able to promote a transaction business as an advice business but without the associated disclosures and standards. Once registered as salespersons, stockbrokers and salespersons  became dealer representatives and business titles changed to advisor and other misleading tiitles which calmed invesrors. .Hence the sudden need for the disclosure of fees , account performance , conflicts- of -interest and client relationships and an increrased regulatory scrutiny of  "advisor " titles and designations.

We have also commented in the past on " Free lunch" seminars, financial pornography , presentations at retirement homes, Fund company webinars , "advsor" use of social media and other " off book" disclosure mechanisms that are loosely covered by securities laws and rules.All of these sorts of  sales communications ( i.e. disclosures of information  designed to promote sales) can be hazardous to your financial wealth. Take a read about what one abused investor has to say about “un-disclosure ” .http://www.investoradvocates.ca/viewtopic.php?f=1&t=180&p=3786#p3786







Sunday, October 12, 2014

Broker Incentives and Mutual Fund Market Segmentation

Broker Incentives and Mutual Fund Market Segmentation Diane Del GuercioJonathan ReuterPaula A. Tkac NBER Working Paper No. 16312 Issued in August 2010 NBER Program(s):AP   IO 

We study the impact of investor heterogeneity on mutual fund market segmentation. To motivate our empirical analysis, we make two assumptions. First, some investors inherently value broker services. Second, because brokers are only compensated when they sell mutual funds, they have little incentive to recommend funds available at lower cost elsewhere. The need for mutual fund families to internalize broker incentives leads us to predict that the market for mutual funds will be highly segmented, with families targeting either do-it-yourself investors or investors who value broker services, but not both. Using novel distribution channel data, we find strong empirical support for this prediction; only 3.3% of families serve both market segments. We also predict and find strong evidence that mutual funds targeting performance-sensitive, do-it-yourself investors will invest more in portfolio management. Our findings have important implications for the expected relation between mutual fund fees and returns, tests of fund manager ability, and the puzzle of active management. Furthermore, they suggest that changing the way investors compensate brokers will change the nature of competition in the mutual fund industry. Read the paper 


Thursday, October 9, 2014

The importance of Risk Profiling

The #1 cause of client complaints is unsuitable investments. The # cause of unsuitable investments is a poor risk assessment of the client risk profile.The article discusses the elements of risk and how to take risk into account when designing an investment portfolio.Read the article

Monday, October 6, 2014

IFIC funded study points the way to reform-our Observations



IFIC sponsored a Study by  The Conference Board of Canada (CB0C) Boosting Retirement Readiness and the Economy Through Financial Advice CBoC is recognized as a professional research house with the highest level of intellectual integrity.. CBoC openly acknowledge that “advisors” do not produce enough extra returns to cover their fees . CBoC argue that the real benefit of having an advisor may not be investment advice at all. It may have more to do with engendering beneficial savings behaviour among clients. They concluded that if more people used investment advisors, they would save more money, and the country would benefit over the long term .As is well known ,“advisors” seek out clients who already have significant investable savings and tend to drop clients who fail to invest enough money over time because these clients don’t generate enough fees .If one reads between the lines, CBoC is saying that account underperformance is significant and the main benefit of advice is an increase in savings rate i.e. a babysitting role. This implies that if lower cost products were recommended , better returns would be obtained AND even more savings would accrue. However, the current Canadian business model where “advisors” sell more expensive ,underperforming actively-managed mutual funds leads to high costs and minimal unbiased advice. This supports a reformed business model where investors pay advisors' separately for tailored advice rather than having the mutual fund company pay for the advice contingent on selling their product..This way ,investors can feel more assured that the recommendations made are in their best interests and if not, they can engage another advisor or become a DIYrs if they feel they are sufficiently competent to control their own financial destiny. This will lead to increasing the number of professional advisors and enhanced financial outcomes for over 10 million Canadians. IFIC deserve credit for engaging CBoC and letting the chips fall where they may.Read our Observations 

Saturday, October 4, 2014

The Costs and Benefits of Financial Advice



The Costs and Benefits of Financial Advice


Abstract : We assess the value that financial advisors provide to clients using a unique panel dataset on the Canadian financial advisory industry. We find that advisors influence investors’ trading choices, but they do not add value through their investment recommendations when judged  relative to passive investment benchmarks. The value-weighted client portfolio lags passive benchmarks by more than 2.5% per year net of fees, and even the best performing advisors fail to produce returns that reliably cover their fees. We show that differences in clients’ financial knowledge cannot account for the cross-sectional variation in fees, which implies that lack of financial sophistication is not the driving force behind the high fees. Advisors do, however, influence client savings behavior, risky asset holdings, and trading activity, which suggests that benefits related to financial planning may account for investors’ willingness to accept high fees on investment advice.Paper by Stephen Foerster, Juhani Linnainmaa, Brian Melzer Alessandro Previtero ,March 8, 2014 Read the Research Paper
 

Friday, October 3, 2014

A Primer on preventing financial abuse and fraud against the elderly

This document is a handy self-protection reference for seniors and retirees who want to avoid financial assault or fraud . Read it here 

Saturday, September 13, 2014

Investor prudence and the Role of Financial Advice

Abstract: Investors have difficulties making optimal long-term financial decisions for reasons such as
shortsightedness, a lack of financial sophistication, and an inability to self-regulate. Using propriety data
collected during the 2007 recession, a period where investors lost over $8 billion by making impulse investment decisions, this study examines the impact of professional financial advice on an investor’s commitment to long-term financial goals. Results suggest that investors who use a professional financial advisor are about one-and-a-half times more likely to adhere to long-term investment decisions. Additionally, investors with a written financial plan are almost twice as likely to make optimal long-term financial decisions. Read the full paper

Wednesday, August 27, 2014

Investor ALERT : Outside Business Activities

Many people don't know that they are vulnerable to solicitation by their “ advisor” for “opportunities " outside the scope of the registered dealer with which they have an account. These are called Outside Business Activities (OBA , also “Off book”) and too often lead to significant losses for investors .  These OBA activities include :



Reps who borrow from clients, allow clients to borrow from them, or who get involved in investment schemes with clients - these have created a major conflict-of-interest which is against the rules . Other "Off book" transactions could include unregistered securities, Ponzi schemes , investment scams,securities sold outside of the dealer, including Principal Protected Notes deemed to be securities under provincial legislation; private placements; limited partnerships; other exempt securities; and, referral of securities related business outside of the dealer - all can cause harm .Be Aware- CAVEAT EMPTOR. Read the ALERT


Friday, August 22, 2014

Fund Facts Risk Disclosure Incomplete

The disclosure of risk in regulated mutual fund Fund Facts documents is currently provided on a five point scale – Low, Low to Medium, Medium, Medium to High, and High. As it stands,,the description of the risk is determined by the fund manager and the risk described captures only the "volatility risk " rather than risk more broadly. A system developed by fund industry lobbyist IFIC is the virtual risk classification industry standard although it has not been subject to public comment or regulatory approval.This simple word scale masks just how bad the loss can be under a "Medium" rating. A number of commenters have observed inconsistencies and misleading ratings using this rating system.There is no requirement to provide a benchmark and as a result there is no context provided to allow an assessment of the described risk or past volatility. In a number of surveys and research reports, respondents more frequently mention "loss of money" as their view of risk i.e. downside risk. Thus they seek a downside risk metric. Investors need to be able to put mutual fund risk and performance in context in order to make an informed investment decision. Fund Facts disclosure of risk should be improved by including a description of the principal factors that make up the “risk” of holding the fund in addition to downside risk measures such as worst 12 months. Most retail fund investors do not understand statistical metrics such as the standard deviation and should not have to. The CSA is reviewing the situation and hopefully the recommendations of investors will be considered. See our Comment letter