The first stage of the client relationship model, Phase 2 (CRM2), came into effect on July 15, 2014. Under this regulatory initiative, which will be fully implemented over the next two years, Canadian financial advisors will likely face the most rigorous investment performance and fee disclosures of their careers.
While a lot of the industry chatter has been around CRM2’s impact on advisor compensation, the effect that CRM2 will have on advisors’ approach to asset allocation for their clients has been missing from the conversation.
Canada is not the first developed market to adopt this type of rigorous disclosure regime. The U.K. and Australia have implemented similar initiatives, designed to enhance investor protection. And, in both countries, statistics show that increased disclosure has had a significant impact on asset allocation for investors.
The U.K. implemented its Retail Distribution Review (RDR) in December 2012. Under this regime, advisors are required to provide increased disclosure of the compensation they receive for their services, make it clear to their clients whether or not the financial advice is offered on an independent or restricted basis, and increase industry-related qualifications.
There were concerns that the RDR would cause large numbers of advisors to leave the business as a result of having to move to a fee-based structure. However, the attrition of 10,000 advisors in the wake of the RDR mostly resulted from having to obtain higher levels of licensing, according to a 2013 study by the U.K.’s Cass Business School at City University in London. According to that study, the big bogeyman – having to make fees transparent – has been, more or less, a non-event.
In Australia, fee disclosure appears to have led to a move toward lower-priced investment funds. Following the introduction of the Future of Financial Advice (FOFA) reforms in July of 2012, the use of lower-fee exchange-traded funds more than doubled to almost AU$12 billion from slightly more than AU$5 billion, according to June 2014 data provided by the Australia Stock Exchange.
While CRM2 may not be as extreme as the RDR and the FOFA reforms, CRM2 will still have an impact on Canadian advisors. As of July 15, 2014, CRM2 has required advisors to disclose a range of charges, including costs related to the purchase or sale of securities and post-trade disclosure of commissions paid on fixed-income transactions. The list of disclosures will continue to grow heading into 2015 and 2016, as advisors will be required to disclose other fees, such as the precise amount of deferred sales charges and trailer commissions.
With this “pay for performance” mentality, I anticipate that old approaches to diversifying client portfolios – the traditional 60/40 asset mix, consisting of 60% equities and 40% bonds – will become obsolete.
Let me explain. Looking at the rolling 252-day average volatility (a key measure of risk) for a 60/40 portfolio over a 15-year period (from Feb. 25, 2002, to Feb. 25, 2014), the portfolio’s risk profile can fluctuate dramatically. While volatility remained low – below a 10% standard deviation – from February 2002 to February 2005, it spiked up to slightly above 25% during the financial crisis of 2008-09, according to Toronto-based PUR Investing Inc.
Having lived through the aftermath of 2008, clients will want to know how adaptable their portfolio mix is to various market conditions. With CRM2’s increased performance and fee disclosure requirements, advisors no longer can get away with using the old 60/40 rule of thumb as the explanation. Clients will want to know the rationale behind their portfolio asset mix and why it was specifically selected for them. As a result, customized portfolios built on an individual’s particular set of risk preferences will become the new vogue.
In countries where these reforms have already taken place, many advisors have begun outsourcing portfolio management. The aforementioned U.K. study found that after the RDR, one-quarter of U.K. investment advisors began outsourcing discretionary asset management.
I expect this trend to carry over into Canada, where more investment product providers will take a more active role in providing asset-allocation strategies for advisors.
The bottom line: more disclosure is a good thing. Advisors can focus on what they do best, helping their clients with their individual investment needs. More disclosure simply does a better job of pointing that out to their clients.
Howard Atkinson is president of Horizons ETFs Management (Canada) Inc., Toronto.
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