Kenmar review of “A Major Setback for Retirement Savings: Changing how Financial Advisers are Compensated could Hurt Less-Than-Wealthy Investors Most “
Except for the title , a few unsubstantiated assertions and conclusion ,there's a lot to like about this paper. The University of Calgary school of Public Policy must've woken up one day and decided it's time to write about embedded commissions. A report of this depth must have cost it at least $100,000 to produce -the timing couldn't have been better – mostly for industry participants.
On page 1 we are presented with this paragraph “ We find that critics of current embedded compensation practices tend to base their policy prescriptions on a truncated analysis of the likely consequences that would unfold if implemented.3 These consequences are much broader and pervasive than investment outcomes. From a public-policy point of view, the “outcome” that truly matters is the impact of financial advice on households’ accumulation of financial wealth and, therefore, how it is affected under different remuneration models. We make the case that voluntary personal savings are unlikely to deliver adequate retirement income unless individual investors have access to expert advice from competent and well-regulated professional advisers and asset managers on terms that are reasonable and conform to their expressed preferences, regardless of whether advice is delivered using commission- or fee-based advice models.”
The Report does contain some solid facts , statistics and excellent reference research materials in an attempt to support the argument that conflicted advice is better than no advice at all. If we didn't know better we might be swayed.
So where do we take issue with the report? First off , it refers to those providing advice as advisers as opposed to their actual registration as sales persons or dealing representatives. It also assumes that the advice is actually delivered but does admit that it could indeed be conflicted. Given the low qualification requirements for mutual fund “ advisors” even if advice is provided , it isn't based on a high standard of proficiency.
The Report doesn't deal with the issue that larger mutual fund investors are unknowingly, and likely unwillingly, subsidizing smaller investors. It also ignores the fact that funds sold by discount brokers collect embedded trailer commissions but don't provide a dime of advice.
As is well known , different advisors do different things (some more; some less) for their clients. In the real professions (law, accounting, etc.) those who do more charge more - and clients willingly pay it. Under the embedded commission model, there's a 'one compensation model fits all' approach - regardless of how much (or how little) the "advisor" does . This could mean that some investors are being overcharged under the embedded commission model.
The report labels investments in mutual funds as savings when in fact they are investments. They are naturally higher for advised accounts than for non-advised accounts. This is to be expected since the advisor is incentivized to sell more funds even if it may be better for the client to reduce ,say , 18% credit card debt or increase life insurance coverage. Without knowing the debt level it is meaningless to refer to account amounts as “savings “ and an advantage of an advised account. Focus should be on income adequacy in retirement rather than savings.
Too many advisors recommend leverage which in most cases is a wholly unsuitable investment strategy for the small investor. The cost impact of bad advice is not reflected in the report but for those who have ever experienced conflicted advice, it can be life altering.
It's easy to think that value of the service you’re getting is implicit, particularly when various pro-embedder Reports like this one routinely reference a 2012 report by the Centre for Interuniversity Research and Analysis on Organizations (CIRANO) which states that investors who have used a financial advisor for 15 years or longer had 2.73 times the level of assets as investors who don’t use an advisor. Sounds great, right? Well, not quite. If you dive a little deeper into the methodology of CIRANO’s research, you’ll find that someone who has fired their advisor—presumably for poor performance—is counted as a non-advised household (even if they used an advisor for more than 15 years!).
The report provides some rationale that a certain fraction of retail investors will refuse to pay for advice if charged separately. [ A study involving retail investors from eight European countries found that between 26 to 30 per cent of respondents were unwilling to pay upfront for advice.87 ] This means that 70-74 % would be willing to pay . In Canada , investors have been told for so long that advice ( such as it is) is free, that the figures will undoubtedly be higher. If a prohibition is applied, the industry, Regulators and governments will need strategies and programs to demonstrate the cost-effective value of professional advice and help make it affordable via productivity improvements , use of technology and creative tax and other strategies .
The report counters this by pointing to research that fee-based accounts are no panacea either. That is true where regulatory enforcement to counter reverse churning is absent which does appear to be the case in Canada. Regulators need to face up to that challenge.
To say that “ .., although studies that investigate adviser behaviour have found surprisingly little evidence that advisers provide unsuitable advice as a matter of course and that other structures of remuneration lead advisers to adopt practices that are better aligned with their clients’ interests ” is plain wrong .The suitability standard along with conflicted advice has caused harm to Canadian retirement income security. The fiduciary/ Best interests structure has demonstrated far better performance and client satisfaction. As an aside , as this report was issued, the US Dept. of Labour decided to proceed with a Best interests duty for retirement accounts.
The report does not suggest imposing a cap on commissions or doing away with DSC funds ( the word deferred doesn't even appear in the report). In essence, the Report strongly recommends the status quo.
The report states “ The existence of a regulatory body that provides oversight to a profession is a signal to consumers that they need not spend resources on costly monitoring in order to reduce self-serving behaviour by the adviser and that there is a mechanism for redress if that behaviour were to occur. “ We totally disagree that mutual fund salespersons constitute a profession ,that CAVEAT EMPTOR is not required and that redress in Canada is robust. There is not a shred of evidence to support that statement.
We also disagree with “ A compelling body of empirical research demonstrates that regardless of their level of financial education and wealth, left to their own devices, individuals’ investment and savings decisions are, as a rule, sub-optimal compared to the results obtained by “advised” investors. “ In fact there are many studies that show quite the opposite. Given that Canada's fund fees are the highest in the world , it is not obvious that unadvised folks would do worse . In fact if they just bought a low cost balanced fund , a life cycle fund or used a robo advisor they could well be far better off. Since the average hold period for funds is about 5 years , it's not even evident that advisors are able to claim they are able to control investor behavioural biases.
Given the emphasis on the financial illiteracy of Canadians one would have thought the solution would involve a Best interests advice standard as investor protection . Of course that would make it hard to justify an embedded commission model which is the apparent goal of the paper.
We do agree that trust in the financial advice industry would certainly be enhanced if there were more discipline and standardization on the use of titles, which, in addition, would facilitate compliance with proficiency requirements. Problem is regulators refuse to tackle the issue. In a 2015 OSC mystery shopping experiment ,a total of 48 different titles emerged. The Report does not actually say that it is necessary to support its conclusion.