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”. 

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