Female advisor meeting with male client at hotel lobby

New research into investment fee disclosures mandated under the Client Relationship Model (CRM2) reforms finds that investors still don’t understand what they’re paying, or what they should do about it.

A report released Monday by the Ontario Securities Commission’s (OSC) Investor Office, which was prepared by U.K.-based behavioural economics firm Behavioural Insights Team (BIT), finds that many investors don’t understand what they’re paying based on the annual fee reports required by CRM2.

In particular, the research indicates that many investors don’t understand that the reports only show dealer fees, and don’t include product costs.

It also says most don’t understand the concept of embedded compensation, such as trailer fees.

“Indirect fees, like commissions paid to investment firms by fund managers, create real confusion among investors,” the report says. “Most of our qualitative research participants did not readily grasp the relationship between investment fund managers and investment firms and therefore how indirect charges work.”

The report finds that the language used in most fee reports is not intuitive, and that some investors have a hard time grasping even basic terms.

“In our interviews, almost all participants had never heard of or didn’t understand terms like deferred sales charge (DSC), trailing commissions, and third-party compensation,” the report says. “Even the terms ‘compensation’ and ‘commission’ were unclear to many interviewees. This problem is made worse by the inconsistent use of terminology across investment firms.”

Ultimately, the research finds that annual fee reports fail BIT’s so-called “flip” test.

“In the flip test you put a communication face down then flip it over. If you can’t understand the purpose within seconds of flipping it over, it has failed the flip test,” the report explains.

In addition to not understanding the annual fee reports, the firm says that many investors may underestimate the impact of the investment costs that are disclosed. Many also don’t have any basis for determining whether their costs are fair or not, and may not be able to act on the information that they receive.

The report includes a list of 24 recommendations to improve the quality of, and investor comprehension of, fee disclosure.

“We found that a simple summary of the most critical information, supplemented with a more detailed description of fees that included explanations of why those fees were incurred, was most effective in boosting comprehension,” it says.

It also suggests that other tactics, such as developing benchmarks that investors could use to test the fairness of their fees, could be useful in making fee disclosure meaningful to investors.

However, the report stresses that the challenge facing regulators goes beyond just making CRM2 disclosure more understandable to investors.

“To capitalize on the promise of CRM2, the sector needs to consider how to support investors in moving from understanding to action,” the report says.

“Supporting investors in making better-informed choices will mean helping them understand their options and reducing the friction in taking action.”

The OSC calls on industry firms to review the report and to consider testing some of the tactics outlined by BIT.

“This behavioural insights research study shows how plain language and attention to disclosure design can place investors in a better position to make informed decisions about their finances,” said Tyler Fleming, director of the OSC’s Investor Office, in a statement. “Improving disclosure can be an effective way to enhance the investor experience.”