Research from the Canadian Securities Administrators (CSA) reveals that efforts to arm investors with more information about the performance and costs of their investments aren’t working.
In August, the CSA published the results of a three-year tracking study carried out by Toronto-based Innovative Research Group Inc. The study was designed to assess investor knowledge, attitudes and behaviour in the wake of reforms to the point-of-sale (POS) disclosure requirements for mutual funds and the cost and performance reporting requirements introduced as part of the client relationship model (CRM2) initiative.
The study revealed that little has changed in key areas, such as investors understanding fees, in the years since the investment industry adopted measures designed to significantly enhance disclosure.
Researchers surveyed investors in March and September of 2017, 2018 and 2019 to gauge their understanding of fees and other subjects. The results were compared with a baseline study carried out in 2016 before the reforms were adopted.
While the study found improvements in investor knowledge, the research also revealed fundamental gaps in investors’ understanding of fees — including that most investors aren’t aware of trailer commission disclosure.
The survey found that in 2019, most investors still didn’t know that information on “indirect fees,” such as trailers, is included in the reports they receive from their investment firms.
Among the investors who reported looking at their account statements, only 42% said they were aware of these kinds of charges. While that figure is an improvement from 29% in 2016, awareness remains far from universal.
The research also found that awareness of trailers and other third-party compensation varied by advice channel. Awareness was weakest among self-directed investors and investors with an advisor without discretionary authority (39% and 37%, respectively), compared with 44% for investors with discretionary portfolio managers and 53% for investors using brokerage advisors with discretionary authority.
The study also revealed just how poorly investors understand fees generally. While only about half of investors knew investment fees existed, almost 75% claimed to know how much they’ve paid in fees over the past year.
In 2019, 51% said they pay fees to buy, sell or hold investments, and a similar percentage (52%) said they pay fees for the management or administration of their accounts. At the same time, 72% reported they knew the amount they paid to their investment firm over the previous 12 months.
The report states these findings reveal a “disconnect” between investors’ subjective knowledge of fees (i.e., how much they paid) and objective facts (i.e., fees exist), and points to possible explanations for these odd results.
Citing behavioural economics research, the CSA report suggests there’s a tendency for survey participants to answer subjective questions “overconfidently” compared with their responses to objective questions.
The report also points to “social desirability” bias as a possible explanation — that the survey participants overstated their subjective knowledge out of a desire to portray themselves as “engaging in behaviour or holding views that are socially deemed to be good.”
There are other apparent disconnects in the research.
For example, 80% of the investors claimed to have a “good understanding” of how fees are affecting their returns; yet 51% of survey participants said they know fees impact returns, and 39% said they understand the impact of all of their fees on their returns.
Again, the report suggests this may be the result of the difference in how people tend to answer subjective vs objective questions; it also could reflect the “social desirability” bias.
Whatever the reasons, overall investor understanding of fees remains poor — pointing to the implausibility of disclosure as adequate investor protection.
The study also found that 89% of investors agreed that it’s somewhat or very important to monitor the amount of fees they’re charged — yet only 69% bothered to read their account statements (essentially unchanged from 70% in 2016).
One hope was that enhancing disclosure would lead to more meaningful conversations between investors and their advisors about fees, but that doesn’t seem to be happening.
While the proportion of investors who reported that their advisor discussed fees with them rose in the immediate aftermath of the POS and CRM2 reforms (in 2017 and 2018, respectively), this action dropped in 2019, indicating that the trend was not sustained.
Similarly, the study found no change from 2016 to 2019 in the percentage of investors reporting that their advisor discussed their financial goals, progress toward those goals and different strategies for attaining them.
Moreover, there’s no evidence that advisors are recommending lower-cost options to clients in the wake of enhanced cost disclosure.
“We’re seeing that Canadians are gaining more confidence in navigating the marketplace. However, there is room for substantial improvement in the investing experience, especially in understanding the impact of fees on investment returns,” notes Louis Morisset, chair of the CSA and president and CEO of the Autorité des marchés financiers, in a statement.
The regulators want to improve the investing experience through further reforms, but these efforts face obstacles.
For example, the CSA’s move to eliminate mutual funds with deferred sales charges (DSCs) is being disrupted by the Ontario government’s refusal to go along with that long-debated policy decision. And the implementation of certain provisions of the CSA’s client-focused reforms is being delayed at the industry’s request.
Some firms in the investment industry contend that improving investor knowledge would obviate the need for more prescriptive regulatory measures aimed at enhancing investor protection. When the CSA decided to eliminate DSCs rather than outlaw embedded compensation entirely, the regulator did so amid arguments from the fund industry that the POS and CRM2 reforms should be given a chance to work before more drastic reforms are pursued.
But the CSA’s survey results are evidence that disclosure alone does not provide adequate investor protection.