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!

AGAIN: the Canadian mutual fund point of sale documentation provides a very limited profile of the recommended fund, for reasons, I would state, that are unrelated to the ability to take responsibility for the transaction.  

Financial literacy research further reinforces the need for clear and simple disclosure.

Regulators seem besotted with the point of sale, and in making sure that information communicated is limited to the “lowest common denominator” that can be understood(literacy) in those possibly few chaotic minutes in which a fund is sold.  This is not advice!   They also forget that the investor needs to have the opportunity to grow and learn about their investments and the advice they receive – they forget about education.  

AGAIN: there is no way you can work out from the information provided whether or not to select any given fund – top 10 holdings, sector allocation and a meaningless risk rating with stand alone performance data is insufficient.  

If the fund is being recommended as part of an overall allocation profile, constructed by the adviser, then a simple explanation of the fund’s profile may suffice, because it is the adviser’s responsibility to make sure that the make up of funds does indeed match the intended portfolio profile – hopefully the adviser/sor would have already provided written and verbal explanation of the asset allocation and risk profile of the portfolio, the investment discipline behind it and how it is designed to manage and deal with risk. 

But even here, with a structure behind it, I still believe you need to explain what each fund is and why it has been selected.  For example: small cap Canadian, value biased and selected for your xyz market small cap allocation because of its discipline, or its yield, or its asset allocation, or the valuation of the underlying and the risk and return profile.   I would also point performance risk issues with the fund and the portfolio – anyone holding a value fund in the late 1990s or a technology fund in the early noughties would understand performance risk of a style or allocation profile.

I also believe that supporting information on a fund’s risk/return, and performance risk profile, relative to its benchmark be made available to the investor, if not just for the sake of expectations management.   This is information an investor may not immediately understand (or indeed ever), but should have access to. Why?  Because it frames the risk and return profile of the fund and highlights any characteristics that differentiate it from its benchmark index.

Now this supporting information should not be central to transaction implementation at a best interests/fiduciary type responsibility level, even though it should be easily accessible and clearly referenced, but it should arguably be mandatory for a suitability standard where the investor is deemed responsible for accepting the suitability of the transaction decision.    Now, clearly, even in a transaction process, the investor is not going to understand this detail, but it has another more important role :

This detailed information supports the advisor’s recommendation and should, in a transaction service process, be a “know your product” screen.  The industry talks about already delivering best interests standards and how difficult it is to base a recommendation purely on cost (I agree), but let them put their money where their mouth is and provide the parameters on which the suitability decision should be made.  

  • Performance relative to its benchmark and the general market index for that fund – in other words, show the alpha.   And why the two benchmarks?  Well, if you are recommending a contrary index position the return profile relative to the market is also relevant.  
  • Comparative risk data, for example standard deviation of the fund, the benchmark and the general market index, if different: while standard deviation provides less relevant information about absolute risks, it does provide important comparative risk information for security selection.  The comparative risk of a fund and its strategy should surely be part of a know your product responsibility.
  • Risk adjusted return information: the Sharpe ratio for example, compared to the Sharpe ratio for relevant benchmarks.   Sharpe ratios are not the be all and end all of suitability, since there are many reasons why a poor ratio is not necessarily bad and a good ratio not necessarily good.   But it does require an assessment of the performance risk profile of the fund and its style and discipline.
  • Correlation information relative to relevant benchmarks.  
  • Yield, asset allocation and valuation based price ratios – i.e. yield, market cap and sector exposure, P/E, P/B relative to relevant benchmarks required to support valuation and style driven recommendations.
  • Costs relative to relevant passive investible indices and/or competitors.

And of course, we have not even talked about the integration of an investment within an investor’s overall portfolio. An investment which passes through the KYC parameters may not pass though the portfolio’s. 

It should be clear that the information needed to ensure that a give fund is suitable, is fairly complex, and that even the intelligent investor unversed in the art of investment statistics would not be able to understand it.  I would suspect that this would also apply to your average investment advisor. 

Thus, the higher the suitability standards, the fewer the funds that will pass the test, the less need there will be for the complex supporting information noted.  The more sophisticated and active the fund, the greater the expertise needed to assess its suitability, the more demanding the rationale needed for its inclusion, and the greater the responsibility on the advisor for its selection. 

The level of detail, and the complexity of that detail, that the average investor must be able to understand to take full responsibility for the investment decision is way above their ability to understand.   But, someone needs to take responsibility for the suitability decision.  Unfortunately we have no requirement to record the investment parameters supporting that decision.  Whether we are in a best interests environment or not, the advisor/er should be responsible for the suitability of the fund selection. 

AGAIN: current regulatory standards are lax and supportive of wide transaction parameters that lay the responsibility on the investor, when it is clear that the investor cannot possible posses the knowledge and expertise needed to make that decision.  The point of sale framework is not designed to protect investors, nor is it designed to inform them in their decisions, but to tick the disclosure box.  

Indeed, while the broad generic suitability standards (KYC) are wide enough for a wide bodied passenger jet to pass through, the product suitability parameters (POS) are effectively non existent.  I would therefore argue that we do not even have fully developed transaction based regulation and processes!  

In fact, the product suitability parameters, for which an advisor should arguably take responsibility, in a transaction based service process, are not a million miles from the information screen that a certain Joe Killoran has been touting for the last two decades.  His argument and delivery may have lacked the finesse needed to thread the point home, but the reality of the true complexity of the suitability decision has been staring everyone in the face for some time. 

While best interests standards are the way to go (it is the only way in which personal financial needs and risk preferences can be effectively related to transaction implementation via structure, planning and management) it should be clear that we are still only regulating 50% of the lamentably lax, non best interests standards, transaction service process.


I would also like to point out that much of the communication about an advisor’s/er’s investment style and discipline would transcend to an understanding of fund’s recommended.   Hence a best interests standard, with better communicated suitability processes, would also deal with many literacy issues associated with a given investment.  A value biased portfolio manager would already have explained the fundamentals of value based investing and where, why and how they allocated.  Their fund selection/asset allocation should complement their style and discipline. 

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