Commission-based model undervalues advice

[Bylo Selhi]

Commission-based model undervalues advice

Defenders of the status quo in the Canadian retail financial services industry must be either hopelessly naïve or utterly disingenuous. In a recent editorial, Investment Executive argued that commission-based compensation structures may not be in the best interests of either clients or advisors over the long run. Not surprisingly, those who are thriving in the current environment take issue with that stance. They claim that product manufacturers are powerless to influence advisor recommendations.

Really? Regulators have concluded otherwise. That’s why they implemented a mutual fund sales practices rule. Moreover, research by the Ontario Securities Commission has since found evidence that advisor compensation, rather than clients’ best interests, is still influencing asset-allocation decisions.

It must also be a stunning coincidence that products that are launched paying high commissions often gather assets with remarkable success. It’s possible that advisors believe they are always acting in clients’ best interests in these situations, but that’s clearly not always the case. Remember the Portus Alternative Asset Management Inc. fiasco?

Yet some in the industry are pushing back at regulators’ modest efforts to improve transparency by requiring point-of-sale compensation disclosure for mutual funds and segregated funds. They claim revealing that information would be too confusing to investors. What’s confusing is a system that embeds advisors’ pay within a product and divorces their compensation from the advice they provide.

Advisors offer a valuable service to investors. Indeed, we believe that it is so valuable that they should be explicitly compensated for it by their clients, rather than allowing it to be devalued through a system of centrally planned and controlled compensation.

We don’t believe that advisors are overpaid; we believe that lousy advisors are overpaid. We do believe that high-quality advisors are underpaid and undervalued by a system that simply rewards quantity over quality. We also find it odd that firms operating in such an inherently entrepreneurial industry are so eager to preserve what amounts to a socialist system of providing financial advice.

This may be in the best interests of the industry’s large players, but we don’t believe it best serves advisors — or their clients.

[DanH]

That was in response to...

In defence of the financial services industry (October 2007 letter)

which was written in response to..

Current commission structure hurts professionalism (August 2007 Editorial)

Try as they might to deny it, financial advisors must face the fact that the industry’s prevailing compensation structures are hurting, not helping, their ascent to professional status.

The sales commission system works well for financial services firms because it gives them leverage over advisors. Both manufacturers and dealers can use commission rates to drive advisors in whatever direction they desire.

Advisors may genuinely believe that they are independent and always act only in the best interests of their clients, but there is plenty of evidence against them. Somehow, new products of dubious value rapidly manage to attract millions of client dollars. And billions in assets crowd into overpriced, underperforming funds while low-cost alternatives remain underutilized.

Advisors’ intentions may be good and their hearts pure, but the fact is that financial incentives work. To date, regulators have been reluctant to interfere with compensation structures, although they did recognize the perverting effect of financial incentives on advice when they crafted the mutual fund sales practices rule. And their own research found that advisor compensation sometimes overrides clients’ best interests in asset-allocation decisions. Yet regulators have been content to rely on disclosure — which they concede isn’t particularly effective — to protect clients.

Even then, firms have resisted enhanced disclosure, arguing that clients really don’t want to hear about it. All of this works fine for firms: it allows them to retain a powerful lever over advisors, and it conditions clients to believe that advice is free (read: worthless). But for clients and advisors, the outcome is less appealing.

Advisors remain shackled to a system that rewards quantity over quality. More important, clients can’t be assured of receiving the unbiased advice they need. And they are the ones who will suffer when they realize they have squandered precious savings on expensive products, overpaid for worthless guarantees or languished in underperforming funds for far too long.

Abandoning commissions won’t solve everything. But a more progressive approach to compensation would at least eliminate inherent bias, mute the influence of firms over the client/advi-sor relationship and allow both sides to put a value on advice.

[InvestingQueen]

Thank you for the post.

I agree with the assessments posted. I am very unimpressed with financial advisors.

HOWEVER, I take larger issue with the sheer stupidity and laziness of investors in general. Why is it that most financial press has a "hate on" for financial advisors but lets the investing public totally off the hook. I am fed up reading about the whining from investors who obviously did not use a single brain in their head.

This is all part of the offloading of personal responsibility which is rampant in our society - who's responsible for investing success - The investor or their commission based advisor - Hummm, seems obvious to me!

As Ann Landers once said "no one can abuse you without you having given them your permission".

Most investors are getting exactly what they deserve as they WILLING CHOOSE to delegate accountabilty to a commission based industry.

It is no wonder that ETF's and strip bonds are "underutilized" because most people have never spent 5 minutes learning about them. Investors, particularly in Canada, are being "processed" by the industry. Hence the "mutual funds are sold, not bought".

Most everyone I know spends more time picking the colour of tiles for their kitchen or spend hours on the net researching vehicle purchases - but do very little if anything to inform themselves about investing - this is particularly true of females.

The internet has revolutionized investing, made key investing information available to all - yet, most people still wander their way to Investors Group and buy DSC mutual funds from AGF.

It is amazing to me that the public distrusts commission based vehicle salespersons, but willing hand over their retirement funds to the same business configuration without an apparent concern.
________________________

I would be impressed if financial "experts" etc would start harassing John Q public - questioning the stupidity of the public might create a more informed client which would then start challenging the investment industry.

The investing industry DOES not have to change, they have millions of obedient customers who love and adore them!


InvestingQueen

[kcowan]

I think the public perception flows from their image of the bank branch manager being a respected member of the community. Having known several, I know they are just poor working stiffs chasing their numbers like the rest of us. The bell curve applies.

[Slippy]

"We don’t believe that advisors are overpaid; we believe that lousy advisors are overpaid. We do believe that high-quality advisors are underpaid and undervalued by a system that simply rewards quantity over quality."

This is sadly so very true.

[blonde]

There is nothing wrong with 'commission'...commission (Money) is an excellent motivator.

Most 90%ers and ALL wannabees do not understand 'value'...their focus is on 'price'. Drawing a picture for them is a total WASTE of time, money and effort...THEY will not understand 'value' one iota.

There is NO Money incentive for the financial industry to educate the [s]slave[/s] sheep. The shareholder demands and supports a Top-Dawg who adds-value to the shares. Marketing is key...Everybody's in Sales...Pay for Performance is a darn good thing.

STUDY the SYSTEM...A financial 'System' is very efficient and effective when the processes include a product/service, customer and multi slaves. The primary metric is MONEY, ALWAYS. Do not be surprised to learn that the primary customer is the 'shareholder'. Smoke and mirrors keep the slaves coming and coming and coming. Why wud the financial industry lock 'em out?

A good/bad advisor is all in the eyes of the beholder.

It is ALL about MONEY...Mega-MONEY.

BTW, trust me, believe me.

[Money101]

Commission-based model undervalues advice

Yet some in the industry are pushing back at regulators’ modest efforts to improve transparency by requiring point-of-sale compensation disclosure for mutual funds and segregated funds. They claim revealing that information would be too confusing to investors. What’s confusing is a system that embeds advisors’ pay within a product and divorces their compensation from the advice they provide.

Amazing! Giving investors basic information is too confusing? What is confusing is the terminology in the mutual fund prospectus and other disclosures where they use far from obvious terms, such as "management expense ratios", to indicate the costs of the fund. New investors do not understand these terms.

Rarely do you see the terms "costs" or "fees" included in the prospectus. No, that would be too easy for the investor to understand and catch on. This is a deliberate ommission by the fund companies. It's sickening.

[parvus]

From National Policy 81-101: Mutual Fund Prospectus Disclosure (p57).

13.2 Illustration of Fund Expenses Indirectly Borne by Investors
(1) Following the disclosure required by Item 13.1, under the heading "Fund Expenses Indirectly Borne by Investors", provide an example of the share of the expenses of the mutual fund indirectly borne by investors, containing the information and based on the assumptions described in subsection (2).

(2) The information to be provided under this Item shall be an investor's cumulative proportional share of the fees and expenses paid by the mutual fund, in dollars, over a period of one, three, five and 10 years, assuming

(a) an initial investment of $1,000;
(b) a total annual return of the mutual fund of five percent in each year, calculated in accordance with section 15 of National Instrument 81-102;
(c) a management expense ratio and operating expense of the mutual fund the same throughout the 10 year period as they were in the last completed financial year of the mutual fund, excluding any performance fees paid in a year which would not have been paid had the mutual fund earned a total return of five percent in that last completed financial year.

(3) Provide an introduction to the disclosure that explains that the disclosure is intended to help an investor compare the cost of investing in the mutual fund with the cost of investing in other mutual funds, shows the amount of fees and expenses paid by the mutual fund that are indirectly borne by an investor, and describes the assumptions used.

(4) Provide a cross-reference to the disclosure provided under Item 8 of Part A of this Form for information about fees and expenses paid directly by the investor.

[blonde]

At the Geritol Club, a few Geritolers were mega-peed-off at the fees charged by the financial guru (UCS)...in short order the guru (UCS) fixed-dat...the fee amount was removed from their statement...now the Geritolers are mega happy, bragging how they are not paying 'fees' and their guru (UCS) is a darn good guru...

Some solutions are simply...KISS...eh?

Don't Trust Anyone.

BTW, trust me, believe me.

[Money101]

Yup, disclosure definitely can be improved in the fund industry. No question, hence it being among the biggest complaints of the industry.