Facing a moral dilemma

[Bylo Selhi]

Facing a moral dilemma

Reaction to the controversial study Mutual Fund Fees Around The World, by Ajay Khorana, Henri Servaes and Peter Tufano, professors respectively at the Georgia Institute of Technology, the London Business School and Harvard Business School, has been fascinating. In fact, it is worthy of a study of its own. Some people attacked the study’s assumptions. Others attacked the mathematics. Some expressed disbelief in the results and some attacked the people who wrote about the study. But the most interesting reaction of all came from some fourth-year students in a financial planning course at a Toronto university college. These students are planning on working in the financial services industry and are hoping to earn their certified financial planner designations.

The students were given a copy of the article, “Cost of investing does matter,” which ran in the October 2006 issue of Investment Executiveand focused on the study. They were asked to assume they were financial advisors and the professor was an unhappy client who had read this article and was asking why the advisor was charging more than the rest of world with respect to the mutual funds he or she had recommended — especially as the client’s return was not as good as the index. The professor asked the students how they would respond.

The first reaction was to defend the fees and assert that the advisor’s services were worth every penny. The next reaction was that these fees were set by the company, so this is what the advisor has to charge. Further prompting resulted in some students saying they would speak to their managers to see if the fees could be lowered. Their enthusiasm for this solution waned when the professor asked whether they realized that by doing so they would be cutting their own compensation. The reaction of the students morphed into: “Well, if this has been the fee structure for so long, why should we change it?”

The professor, who has had a multi-faceted and long career in the financial services industry, used the scenario to highlight the conflict financial advisors often face in taking care of their own interests and those of their clients. He also used it to stress the importance of financial advisors taking into account the impact of fees on the value proposition for clients. This finally turned the discussion to the question of whether clients are getting a fair shake.

The lesson ended with a heightened awareness that there is a lot in the financial services industry that favours fund managers and that once the students join the work force, they will have to face this moral dilemma. They will have to answer the questions of knowledgeable clients. They have to prepare themselves for the future — not just because of negative articles in the press, but because clients’ needs must come first if advisors are to meet their fiduciary obligations.

It is a lesson that bears constant repetition. And one that financial advisors who best serve their clients’ interests must live by. It is crucial that education and training programs of those entering the industry emphasize these points, and that product and service offerings meet the needs of clients rather than the needs of financial services providers. It is essential for the well-being of Canadians and the ongoing viability of the industry that financial services providers review their offerings with the needs of clients in mind. And that they be held accountable if they do not.

[Nemo2]

The first reaction was to defend the fees and assert that the advisor’s services were worth every penny. The next reaction was that these fees were set by the company, so this is what the advisor has to charge. Further prompting resulted in some students saying they would speak to their managers to see if the fees could be lowered. Their enthusiasm for this solution waned when the professor asked whether they realized that by doing so they would be cutting their own compensation. The reaction of the students morphed into: “Well, if this has been the fee structure for so long, why should we change it?”

Sounds as if government owned & operated mutual funds are imminent........these guys appear ready for them.

[Bylo Selhi]

The first reaction was to defend the fees and assert that the advisor’s services were worth every penny. The next reaction was that these fees were set by the company, so this is what the advisor has to charge. Further prompting resulted in some students saying they would speak to their managers to see if the fees could be lowered. Their enthusiasm for this solution waned when the professor asked whether they realized that by doing so they would be cutting their own compensation. The reaction of the students morphed into: “Well, if this has been the fee structure for so long, why should we change it?”

Sounds as if government owned & operated mutual funds are imminent........these guys appear ready for them.

How so?

BTW the part of the paragraph you quoted that I bolded is a perfect confirmation of Upton Sinclair's aphorism, "It is difficult to get a man to understand something when his salary depends on his not understanding it." What's particularly disturbing is that these are still students who presumably haven't yet earned a dime in the business, but they already "get it." Hence Stromberg's call to action.

[Nemo2]

How so?

How so?

Well....they certainly sound like elected officials justifying their perqs, entitlements, and the status quo............that, and offering vague promises about, (perhaps), investigating possible reforms..........somewhere down the road.

[NormR]

Further prompting resulted in some students saying they would speak to their managers to see if the fees could be lowered. Their enthusiasm for this solution waned when the professor asked whether they realized that by doing so they would be cutting their own compensation.

And yet, the budding advisors could cut overall costs while increasing their compensation. Just follow the De Goey route.

As a result, you're only seeing the reaction of students to a fibbing professor.

[scomac]

I'm currently wrapping up the fourth course towards a Financial Planning Certificate at Mohawk College, in Hamilton. The successful completion of this course is a prerequisite to writing the CFP registration exams. The first thing that needs to be addressed with respect to the students' commentary in the linked article is that [s]many[/s] most are already in the industry and are taking these courses as part of their continuing education process (at least that is my experience with my class group). I think that it's a false conclusion to assume all new entrants into the field "get it" before they've become engrained within the system as we currently know it.

In my experience, as a result of taking these courses, the breadth of knowledge necessary to become well versed in all topics of financial planning is almost overwhelming. Selecting suitable investment products for a client is only one rather small piece of the puzzle. Yet, this is the area that was being focused on with respect to the concerns of a hypothetical client as mentioned in this article. If an advisor shifts the focus from investment performance to the total planning process, then perhaps the "cost matters" issue can be more fairly delt with. If the instructor hasn't made this point, than an opportunity has truly been lost.

I'll agree that some of the highlighted commentary by the students gives one some concern and this is how the article is being presented with a definite bias. Hopefully the instructor took advantage of this to impress upon the students the need to approach this issue from the proper perspective.

I must admit that I have a much higher respect for the total financial planning process than I did before taking these courses. This is a result of learning about all the various nuances in planning vs. a singular focus on investments and their return. Unfortunately, this is where most retail investors will focus because the numbers are infront of their face every month or quarter. I don't see anything that quantifies the benefits of risk management, estate planning, retirement planning or any of the other topics that would be dealt with in a financial planning relationship. What's it worth to you to have these issues covered for your own piece of mind and benefit?

For all the flaws in the system as we know it, I'm increasingly of the mind that the benefits out weight the costs for the vast majority of clients. ISTM that Dan H has in the past provided an example of how the commission system was a pretty good deal for clients with more limited assets.

[NormR]

A copy of the article the students were evidently asked to discuss...

Cost of investing does matter

The study finds that, after adjusting for fund type, fund size, complex size and other variables, Canada has the highest fees by far. The authors say the all-in cost of holding a mutual fund — including the sales charges some funds levy when money is withdrawn after five years — would amount to 4.68% of an investor’s assets each year. This, they say, compares with 1.68% a year in the U.S., where deferred sales charges are less common, and with an average of 1.84% in 14 other countries.

The poor students were asked to comment on the debunked ~10% Canadian loads.

I note that the original draft paper (from which the 4.68% 'TSC' number comes from) says, in a footnote, "Morningstar has little data on the loads charged by Canadian funds, so TSCs may not be representative, given that they are computed for only a small number of funds."

It is unfortunate that the Canadian TSC number has been relied on (and given an extraordinary amount of press) given the explicit warning by the authors of the draft paper (which has yet to undergo peer review).

[Bylo Selhi]

I'm currently wrapping up the fourth course towards a Financial Planning Certificate at Mohawk College, in Hamilton. The successful completion of this course is a prerequisite to writing the CFP registration exams. The first thing that needs to be addressed with respect to the students' commentary in the linked article is that [s]many[/s] most are already in the industry and are taking these courses as part of their continuing education process (at least that is my experience with my class group). I think that it's a false conclusion to assume all new entrants into the field "get it" before they've become engrained within the system as we currently know it.

Good point. Thank you.

In my experience, as a result of taking these courses, the breadth of knowledge necessary to become well versed in all topics of financial planning is almost overwhelming. Selecting suitable investment products for a client is only one rather small piece of the puzzle. Yet, this is the area that was being focused on with respect to the concerns of a hypothetical client as mentioned in this article. If an advisor shifts the focus from investment performance to the total planning process, then perhaps the "cost matters" issue can be more fairly delt with. If the instructor hasn't made this point, than an opportunity has truly been lost.

The article talks about students' reactions to an article that purports to show that Canadian fund MERs are amonst the highest in the world so it's not surprising that it would focus on "costs matter" rather than the planning process.

In any case, many of us have commented for years that it's hard to get the public to appreciate the value of financial process, both in terms of the amount of effort that a planner has to put into it if they want to take it seriously and in terms of the value the client can get from it as a result, when the client pays for product (the fund sales that flow from the process) rather than for service (the process itself.) Moreover, the industry treats all planners identically in terms of compensation regardless of the work they do and the value they provide. This can range from zero (in the case of discount brokers) all the way to "priceless" (in the case of competent planners who take their jobs seriously.)

I'll agree that some of the highlighted commentary by the students gives one some concern and this is how the article is being presented with a definite bias. Hopefully the instructor took advantage of this to impress upon the students the need to approach this issue from the proper perspective.

Everyone has bias. The prof was trying to sensitize the students to their reactions to the paper in an effort to make them appreciate the bias that's inherent in the conflict of interest that they experienced over fees.

I must admit that I have a much higher respect for the total financial planning process than I did before taking these courses. This is a result of learning about all the various nuances in planning vs. a singular focus on investments and their return. Unfortunately, this is where most retail investors will focus because the numbers are infront of their face every month or quarter. I don't see anything that quantifies the benefits of risk management, estate planning, retirement planning or any of the other topics that would be dealt with in a financial planning relationship. What's it worth to you to have these issues covered for your own piece of mind and benefit?

Exactly. That's the challenge. "Good" advisors face it by ensuring that their clients have a comprehensive financial plan and an IPS to implement it, along with full disclosure of the costs involved and regular feedback. It seems to me that most industry critics simply want to ensure that this sort of value is delivered by all advisors and not just the "good" ones.

For all the flaws in the system as we know it, I'm increasingly of the mind that the benefits out weight the costs for the vast majority of clients.

In any case it behooves the industry to strive towards ensuring that's true not just for the majority of clients but for all of them.

ISTM that Dan H has in the past provided an example of how the commission system was a pretty good deal for clients with more limited assets.

Yes, that's a big challenge since so many Canadians lack the size of portfolio that can justify a full financial plan, etc. The industry needs to find innovative ways to address this problem rather than trying to fit everyone with assets ranging from a few $1,000s to 100+ times as much into the same 2.5% MER fee structure. Perhaps someone with only $10k or $25k don't need a full financial plan and a complex portfolio of expensive funds, but rather they need help to develop the sort of spending/saving habits that result in the accumulation of larger portfolios. Perhaps those folks would be better served by simply making regular contributions to a low-cost balanced fund inside an RRSP...

[scomac]

In any case, many of us have commented for years that it's hard to get the public to appreciate the value of financial process, both in terms of the amount of effort that a planner has to put into it if they want to take it seriously and in terms of the value the client can get from it as a result, when the client pays for product (the fund sales that flow from the process) rather than for service (the process itself.) Moreover, the industry treats all planners identically in terms of compensation regardless of the work they do and the value they provide. This can range from zero (in the case of discount brokers) all the way to "priceless" (in the case of competent planners who take their jobs seriously.)

This is the crux of the problem. ISTM that the majority of Canadians are loath to pay for professional advice. Why pay a lawyer for a proper individualised will when you can do it yourself with a will kit? Why have a continuous relationship with a CA when you can get your tax filing (forget planning) done by the revolving door folks at HR Block or similar firms? Why pay for financial planning advice when you can simply buy a Pape book and pick your own funds? They just don't seem to understand that cookie cutter solutions may not be in your best interest. Some how the "Cost Matters" agrument misses all of this, or at least places the onus on the consumer to make the determination with what is likely to be a very incomplete fact set.

[DanH]

Reaction to the controversial study Mutual Fund Fees Around The World, by Ajay Khorana, Henri Servaes and Peter Tufano, professors respectively at the Georgia Institute of Technology, the London Business School and Harvard Business School, has been fascinating. In fact, it is worthy of a study of its own.

Indeed, actions speak volumes. I e-mailed Ms. Stromberg a month ago asking if she really believed the 4.68% TSC figure was representative of Canadian fund investors. I have yet to receive any response.

Some people attacked the study’s assumptions. Others attacked the mathematics. Some expressed disbelief in the results and some attacked the people who wrote about the study.

Guilty...guilty...guilty...not guilty.

I could go on but I think it wise to stop here.

[Bylo Selhi]

Why pay a lawyer for a proper individualised will when you can do it yourself with a will kit? Why have a continuous relationship with a CA when you can get your tax filing (forget planning) done by the revolving door folks at HR Block or similar firms? Why pay for financial planning advice when you can simply buy a Pape book and pick your own funds? They just don't seem to understand that cookie cutter solutions may not be in your best interest.

Perhaps sometimes the simplest solutions are the best. Someone with a small estate may not be best served by a professionally-planned will, especially not if it costs them 10x or more than a will kit. After all if they die prematurely there won't be much to divvy up even it doesn't all go to the intended heirs. Same with taxes. If you're a wage-earner without many other assets then what's the harm with DIYing the tax return? You may miss an opportunity to save $50 in tax, but why is that a problem if it will cost that much or more to save it by using a tax preparer. And if someone ripped you off for say $200, would you hire a lawyer to sue them, or would you simply dust yourself off having learned a lesson, or possibly DIY in small claims court? The point is that professionals aren't necessarily the only or best option.

So it is with financial planning. What can a financial planner offer someone with $10k in assets (say $100/year in compensation out of $300 in MERs) or even $20k or $30k beyond a minutes a year, mostly over the phone? Surely not a comprehensive financial plan. So perhaps someone in that situation is best served by reading a book like The Wealthy Barber and investing in a single balanced fund (e.g. PH&N for 80 bp) until they have enough assets to justify the cost of engaging a competent financial advisor.

[saylavbda]

This is the crux of the problem. ISTM that the majority of Canadians are loath to pay for professional advice. Why pay a lawyer for a proper individualised will when you can do it yourself with a will kit? Why have a continuous relationship with a CA when you can get your tax filing (forget planning) done by the revolving door folks at HR Block or similar firms? Why pay for financial planning advice when you can simply buy a Pape book and pick your own funds? They just don't seem to understand that cookie cutter solutions may not be in your best interest. Some how the "Cost Matters" agrument misses all of this, or at least places the onus on the consumer to make the determination with what is likely to be a very incomplete fact set.

IMHO, I think its more of an issue that the majority don't see the value in paying professional fees. In some cases correctly, in others not.

I would argue that the onus should be on the service provider to show the consumer their value proposition. I've dealt with major CA firms, and I would think most would say that their services are too expensive for the average Canadian who have limited planning needs and simple returns and are better served by H&R block, or buying a tax package.

The fact that most advisors don't charge by the hour and that the industry as a whole is less than clear about the costs paid for the advice shows a lack of confidence that they could fully justify their value proposition.

[tidal]

Upton Sinclair's aphorism, "It is difficult to get a man to understand something when his salary depends on his not understanding it."

I think Bogle used this quote at some point, and so the indexers love it, but Descartes beat Sinclair to it by about 300 years.

Man is incapable of understanding any argument that interferes with his revenue.

[NormR]

Upton Sinclair's aphorism, "It is difficult to get a man to understand something when his salary depends on his not understanding it."

I think Bogle used this quote at some point, and so the indexers love it, but Descartes beat Sinclair to it by about 300 years.

Man is incapable of understanding any argument that interferes with his revenue.

You can just as easily remove money/reveune and insert mental model.

Confirmation bias

Confirmation bias is a phenomenon wherein decision makers have been shown to actively seek out and assign more weight to evidence that confirms their hypothesis, and ignore or underweigh evidence that could disconfirm their hypothesis. As such, it can be thought of as a form of selection bias in collecting evidence.

Disconfirmation bias

Disconfirmation bias refers to the tendency for people to extend critical scrutiny to information which contradicts their prior beliefs and accept uncritically information that is congruent with their prior beliefs.

[Ed]I can easily say that I've been guilty of both from time to time.

[Beta Squared]

And yet, the budding advisors could cut overall costs while increasing their compensation. Just follow the De Goey route.

While this is essentially true, it is very difficult to follow this route without an existing client base. Any one who has done the transition from commission to fee base will tell you that there is a period of time that you will take a hit on earnings. I suspect that it would be doubly difficult to start from scratch.

[NormR]

And yet, the budding advisors could cut overall costs while increasing their compensation. Just follow the De Goey route.

While this is essentially true, it is very difficult to follow this route without an existing client base. Any one who has done the transition from commission to fee base will tell you that there is a period of time that you will take a hit on earnings. I suspect that it would be doubly difficult to start from scratch.

True.


But in this case, the students should just point out that they can cut costs (from ~4.7%) nearly in half by simply using a rather average collection of funds. They can then be 'heroes' to their clients who think that the average fund cost in Canada is near 4.7% annually.

[Norbert Schlenker]

But in this case, the students should just point out that they can cut costs (from ~4.7%) nearly in half by simply using a rather average collection of funds. They can then be 'heroes' to their clients who think that the average fund cost in Canada is near 4.7% annually.

The sorry truth is that 1/2 of 4.7% - which is close to correct for Canadian funds - is still the highest rakeoff in the OECD. The study's numbers are wrong but that doesn't mean Canadian investors aren't being taken to the cleaners.

[flywaysuzy]

Well, we used to have a CA do our taxes, at least he did for the first year or two, then we got downgraded to his clerks doing our taxes and the price doubled to two hundred dollars, at this point we bailed (or maybe baled, since a small portion of our income and large portion of our tax complications come from our little farm...) and we now have a retired teacher do them for $100. If the CA was giving us any kind of value added advice on how to reduce taxes, or plan ahead, then the extra money would have been well spent. We get more advice for our $100 than we have time to listen to. Maybe when we retire we can see the advantage to depreciating more things instead of writing them all off in a year! Maybe then I would even have time to do the quarterly GST thing...or maybe not!