A recent report authored by York University’s Douglas Cumming for the Canadian Securities Administrators (CSA), entitled Dissection of Mutual Fund Fees, Flows and Performance, used aggregated, fund-level data to test for correlations between levels of trailing commissions and fund unit sales. And, indeed, the data tell a story, but an incomplete story.
Decisions about which fund to recommend are complex and cannot be fully captured by fund-level data analysis, no matter how academically sound the model. Such analysis cannot consider measures that matter to and influence investors, such as account-level performance and the ability to meet financial objectives. Nor can aggregated data evaluate sales in the context of providing investors with the most suitable products or the potential costs of chasing performance.
These observations are not a criticism particular to Cumming’s research. Other recent reports were similarly limited, including a review of academic literature: Mutual Fund Fee Research, by the Brondesbury Group; and Analysis of the Factors Influencing Sales, Retention and Redemption of Mutual Fund Units, by Investor Economics Inc.
There is room for constructive criticism with respect to some of the opinion-based statements made by the Cumming report and by comments on the report. For example, the Cumming report states: “Both affiliated dealer flows and the payment of trailing commissions result in material conflicts of interest that are detrimental to mutual fund investors over the long term.” Aggregated data analysis can identify a degree of relationship; this analysis cannot tell us why this is occurring or whether there is harm to individual investors.
Cumming found that past performance was the single most important driver of sales and redemptions under all fund fee models. He also found that fee-based sales are more sensitive to past performance than commission-based sales are, but could not say why. Account-level research is needed to understand whether the sensitivity is a result of fee-based financial advisors pursuing past performance or a result of other factors. (For example, that commission-based accounts are more in line with buy-and-hold investment strategies, such as those typical of pre-authorized contribution plans.)
The Brondesbury report notes that an ideal study “would involve comparisons of individual clients and advisors over time spans of a few years, with a sample that includes clients served through different compensation models.” The report observes that every compensation model generates some conflict and there is “no such thing as a behaviourally neutral compensation model.”
The Brondesbury report’s conclusions are reinforced by the Investor Economics report, which states that a definitive examination of the drivers of advisor and investor decision-making requires “matched transactional data, amplified with information regarding individual advisor practice, the composition of the advisor’s product shelf and individual client characteristics.”
The Investor Economics report found that a complex interplay of more than 40 factors drives fund flows. Principal influences were external macroeconomic factors – which can overpower all other factors – investment returns and distribution channel. Where trailers were observed to play a role, the impact was not significant when relative fund performance ratings were taken into account. In the real world, absolute and relative performance metrics are the measures that commonly are available to advisors and their clients, and are fundamental to understanding how advisors and clients decide which funds to buy or redeem.
There has been criticism of the Investor Economics report for not using the same methodology as Cumming used. This is unwarranted. The Investor Economics study was not intended to replicate the Cumming study; rather, the goal was to add further analysis to the questions under discussion. There would have been no value in using the same data and methodology because the objective was to make a contribution, not to issue a challenge.
All these reports, along with evidence from international jurisdictions that have made changes to compensation rules, are useful to future CSA investigations and decision-making. Other research into Canadian investors’ experience also will be important.
Already, the CSA is conducting detailed research to understand whether increased disclosure (using Fund Facts and Phase 2 of the client relationship model) has an impact on investor understanding and decision-making. This long-term research will provide important insight into the effectiveness of cost disclosure on investor behaviour within Canada’s unique regulatory and cultural contexts.
More account-level research will be needed to understand the full implications of regulatory intervention in compensation arrangements between investors and their advisors.
Joanne De Laurentiis is president and CEO of the Investment Funds Institute of Canada.
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