Are Canadian regulators ring fencing consumer investing behavioural biases in favour of transaction returns?

“we suspect that much of what we see as impact of compensation is just investors failing to make rational decisions.” P53 of the Brondesbury Report on Mutual Fund Fees.

I am in the midst of reviewing the CSA commissioned Brondesbury Report on Mutual Fund Fees and am ploughing through the reference material which supposedly underpins its conclusions.  Amongst the many nuggets I have unearthed is the following taken from “Investors’ Optimism: A Hidden Source of High Markups in the Mutual Fund Industry” :

Previous works have identified investors’ optimism bias towards equities issued in their domestic market. In particular, academic research on mutual funds has focused on investor’s lack of financial literacy. …These empirical findings of investor’s deviation from rationality are in line with our model’s emphasis on investor’s limited financial knowledge of the mutual fund industry.

Investors’ optimism bias can be closely related to their lack of knowledge of the fund market, leading them to choose sub-optimal benchmarks such as bank savings instead of low-cost index funds or ETFs. Besides, investors’ optimism bias is probably influenced and reinforced by the marketing practices of mutual funds, which promote the sale of fund shares.

The reference to sub-optimal benchmarks is both noteworthy and ironic because both the new Point of Sale disclosure documentation for mutual funds and the performance reporting requirements laid down in the CRM2 lack mandated performance benchmarks. 

Interestingly the Canadian Securities Administrators had earlier proposed a GIC or cash based benchmark for Point of Sale mutual fund disclosure documentation, but baulked at the last minute for a number of reasons. 

So why were Canadian regulators looking to implement “sub optimal benchmarks”?  Were they ring fencing consumer behavioural biases in the interests of transaction remuneration or were they themselves acting in ignorance?  We may never know but the point is an interesting one and much more so given the deeper contextual focus in the  Brondesbury report on investor behavioural biases (chapter 5):

“Behavioral biases of investors are not easy to overcome. Behavioral biases affect advisor behaviour (just as advisors affect investor behaviour), investor choices of investment, and ultimately, investor outcomes”

“Time is a precious commodity to most advisors. There is only so much time an advisor can afford to spend to overcome the behavioral biases of investors, regardless of how they are compensated”

Investor behaviour biases lead to sub-optimal returns and these biases can be confused with compensation impacts

Behavioral biases of investors are not easy to overcome and they are a key factor in sub-optimal returns on investment. This poses a real limitation of the conclusions we can draw from the research literature, when we look solely at clients of commission-based advisors.

If there is no comparison between different forms of compensation, one can easily be misled into believing that sub-optimal behaviour is the result of the advisor’s recommendations and not, at least in part, the behavior and attitudes of the investor.

There are two issues related to behavioral biases that must be mentioned here. The first is the question of who is responsible for overcoming the behavioral biases of individual investors. While helping clients to do so may be something that a top-notch advisor will choose to do, we are not aware of any rule or principle that points to de-biasing as an advisor or a firm responsibility, regardless of compensation scheme unless a failure to do so impacts ‘investment suitability’ in some way.

“we suspect that much of what we see as impact of compensation is just investors failing to make rational decisions.” P53 of the Brondesbury Report on Mutual Fund Fees.

This quick post introduces some of my concerns with the Brondesbury report and my belief that many of its conclusions and analysis remain mired in a transaction mindset that continues to beset regulation of advice in Canada.   Regulators and, it would seem, some esteemed others appear mired in a perplexing behavioural bias towards “what does and does not represent investment advice”. 

Does the disclosure received by retail investors help them to make optimal investment decisions?”

I was happy to attend the Capital Markets Institute’s discussion on disclosure at Toronto’s Rotman School of Management.  But some 3 and a 1/2 hours after the start, the panellists had still not answered the headline topic of discussion: “Does disclosure help investors make optimal investment decisions?”

Outside of the academic presentations by Sunita Sah and an interesting but jocular presentation on behavioural issues affecting choice, focus seemed to be almost entirely on documentation underpinning investment details, costs and performance, i.e. the disclosure of detail. 

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Are they advisors or salespersons and do we have a transaction or an advice based service process?


I was thinking of submitting a few arguments to round 3 of the point of sale framework, but flogging a dead horse gets kind of tiresome after a while and also raises questions over one’s own intelligence.  

Needless to say I have not been surprised by many of the industry or “industry funded” comments.   I would like nevertheless to draw attention to some points made in the Fasken Martineau submission.

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My submission to the CSA re Risk Classification disclosure

Re: CSA Notice 81-324 and Request for Comment – Proposed CSA Mutual Fund Risk Classification Methodology for Use in Fund Facts

The part must relate to the whole and the whole to the part and the both must know of it:

The CSA in their consultation paper fail to explain how the risk classification methodology proposed for use in the point of sale documents is to be used by investors to make informed decisions, and how advisors are to use the same to determine suitability.

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Why are benchmarks important in mutual fund point of sale documents?

In response to a recent blog on benchmarks and behavioural economics I have been asked to comment on the importance of benchmarks in point of sale documents.  The following is the detail supporting that response, and (at the end of the post) a set of answers to a number of questions:

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A green light for low ethical standards or has “best interest standards” been given the go ahead?

Leaders lead and set standards and examples.  Yet, with the Canadian mutual fund point of sale document we have, inter alia, a) something which has been allowed to be sent after the transaction and b) something in which information critical to making informed decisions has been taken out of the frame or dumbed down so as to be worthless.

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Regulators + Behavioural Economics = social engineering & the “mutual fund bliss point”

You gotta keep them focussed on the transaction, otherwise they wander and cannot make up their minds..sometimes they just need to be nudged in our direction and not away from it..”, you can almost imagine someone quipping at a recent OSC dialogue.

Sometimes, and at times more times than you would wish, you have to wonder if the cards are being deliberately stacked against the consumer in plain view.

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What is investment risk?

“What is investment risk” is both simple and complex and in order to assess the information needed to assess risk we first of all need to qualify the world view of risk and return and then the model we are using to manage the risks and their impact. All this is beyond the subject matter expertise of the individual investor and why point of sale documentation can only ever inform about the broad nature of risk and return but never be sufficient to allow the investor to fully own the decision. Ownership of the transaction decision resides with ownership of the process and the significance of risk assumed with respect to risk via structure, assumptions and costs.

At a very basic level, risk is what happens to a price between two points in time and the impact of that movement in price – it can be both positive and negative.  But what gives rise to risk is more important than a mere list of risk factors, or indeed a narrow quantitative measure of risk.

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Oh, and by the way, they shot the token benchmark!

While best interests standards are the way to go, in my opinion, it should be clear that we are still only regulating 50% of the lamentably lax, non best interests standards, transaction service process. 

June 13 saw publication of the CSA’s implementation of stage 2 of point of sale disclosure for mutual funds.  And by the way, they shot the token benchmark!

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At this rate, propaganda may be the OSC’s only effective plan….

Investor beware, in the absence of concrete regulatory change, the OSC may have to rely on gradually introducing an idea of investor confidence into your mind.

The OSC has just published its 2013/2014 statement of priorities.  It is bland, uninspiring and fails to make a firm commitment, either way, on the key issues of our day.  The OSC, once again, is preferring the warm fuzziness of further discussion and consultation to the realities of conflict and commitment.

Blithely ignorant of the increasing body of research that raises considerable doubt over the efficacy of disclosure, the OSC continues to rely heavily on this out dated remedy. 

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Give investors the confidence to ask questions… Will this really solve the problem?

Another loop back from the recent IFIE IOSCO Investor Education conference.   One comment stream that attracted the attention of my pen and paper was the following:

“There will always be asymmetry”…”to give them confidence to ask the questions they need to ask”….”become confident enough to ask questions questions”….”take a pass if they do not get the answer they like”.

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Is cash an appropriate benchmark for an equity based investment and just what is it doing in the point of sale document?

Canadian regulators are still implementing Point of Sale disclosure documentation for mutual funds, and FAIR, a regulatory think tank funded by the OSC and IIROC, has recently sent its submission on phase 2 implementation of the project.

Much of what FAIR says is spot on, but I disagree with their comment that a cash based investment is an appropriate benchmark for a mutual fund investment.

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