This article appeared in the March 2022 issue of the monthly magazine Advisor’s Edge magazine. Sign up for the print edition, read the digital edition or read articles on the Internet.
It’s been five years since clients received the first annual reports showing investment fees and performance under the Customer Relationship Model (CRM2) reforms, and there is growing evidence that these disclosures are not working.
Research has shown that few investors can determine the total cost of an investment or the types of costs included in fee summaries. Many clients are confused by common industry terms such as commissions, or the distinction between mutual fund managers and dealers.
“Is it working?” – asked Sybil Verch, head of private client solutions at Raymond James in Vancouver. “Here we are five years later. Have we achieved what we set out to do? I think the answer is no.
Regulators hoped the reforms would improve investors’ understanding of the fees they charge. Neil Gross, chair of the Ontario Securities Commission’s (OSC) Investor Advisory Panel, said CRM2 “didn’t really move the needle.”
“CRM2 has never been a perfect solution to the problem of making unsophisticated investors aware of the costs they incur in connection with investments,” Gross said.
In fact, Gross found that by focusing solely on the money paid for the investment advisory portion and omitting fees paid to mutual fund managers, the disclosure may have inadvertently led some investors to believe that their fees were lower than they actually paid.
Even before CRM2 came into force, the industry discussion was moving towards reporting total costs, which include fund fees. As Canadian securities administrators prepare to release CRM3 proposals this year aimed at standardizing and streamlining cost disclosures for both mutual funds and segregated funds, experts say the way information is presented on fee schedules is at least as important like what information is included. Advisors should also not be afraid of additional disclosures, but should view these statements as an opportunity to build trust with skeptical clients.
How are we doing so far?
The CRM2 reforms came into effect in July 2016, giving firms one year to provide clients with the first reports showing investment performance and fees paid to the dealership.
Since the changes came into force, the industry has been monitoring investor understanding. For the most part, the results are not encouraging.
The Investment Fund Institute of Canada’s (IFIC) annual investor opinion survey shows little progress since 2017 in clients’ understanding of fees based on their annual reports. In a 2020 survey (the most recent at press time), only about half of clients said the statements clearly indicated compensation paid to their advisor’s firm; almost every fourth rated the statements “poor” in this category. In 2017, more respondents found the statements easy to understand than in 2020.
The Behavioral Insights Team (BIT), a UK-based consultancy, prepared reports on CRM2 for the OSC in 2019 and for the Mutual Fund Dealers Association of Canada (MFDA) in 2021. BIT found that less than one in five investors can identify the types of costs included in fee summaries and that there is a lot of confusion around built-in fees such as trailer fees. Many investors did not understand that the reports only show the fees paid to their dealer and do not include the cost of the product.
An inspection of CRM2 reports submitted by IFIC dealers found that the statements contained jargon and technical language and contained text at a college graduate’s reading level – significantly higher than that required for investor understanding.
More is more
BIT research commissioned by the MFDA found that investors want enhanced cost reporting and the addition of fund charges to statements has improved their understanding. However, the way the information is presented will be crucial.
Toronto-based consulting firm BEworks, which conducted the study for IFIC, found that using simple language, breaking down topic information and eliminating jargon can improve customer understanding (see “How to improve your annual fee reports” below). IFIC is working on an updated model statement that incorporates some of the findings from the BEworks research.
David Lewis, president of BEworks Research Institute, said that while annual reports are a snapshot of the past, they should be presented with an eye to the future. This means showing a client’s performance and fees in the context of their investment goals so they can understand the actions necessary to achieve their goals.
The “big picture” should show how fees, market performance and portfolio contributions are related, he said, and linking a client’s goals to behavior gives clients context and incentive to read what they’re saying.
“If people understand all these things and how they fit together, they will be more trusting,” said Lewis, the recently appointed OSC commissioner. (He talked with A.E as a behavioral expert and his views do not necessarily reflect those of the committee.) “In many cases, the client’s fear is greater than reality.”
A common industry concern is that reporting total costs would overwhelm clients or cause them to focus on investment costs at the expense of other factors. However, Lewis said that properly presenting fees “does not make customers more price sensitive – quite the contrary. Thanks to this, they become more trusting and more willing to listen to advice.”
The BIT said the amounts paid to dealers and mutual fund companies should be included in one table, and the companies should provide a short preamble containing information on the impact of the fees and clearly defining the terms.
Gross said that while regulation is moving toward principles-based rather than prescriptive policies, he hopes that with CRM3 “we will see regulators specify exactly how information should be presented.” Part of CRM2’s inefficiency is because regulators haven’t mandated reporting, he said.
BEworks research into IFIC dealer member statements found that CRM2 reports varied in length from two to 20 pages.
“If a regulation does not specify an effective method of presentation and leaves it to the industry to present the information in any way it chooses, the presentation of the information may not be – and often clearly is not – effective,” Gross said.
The OSC Investor Advisory Panel, chaired by Gross, said the statements should go beyond reporting annual fees and show the impact of long-term pooling of fees. “Few investors realize that 1% or 2% of annual fees can eat up 25-50% of their total investment return over the long term,” said the panel’s response to the MFDA’s 2018 CRM3 discussion paper.
Warning: cognitive overload
Experts also warned against overloading investors with information. While survey data indicates that Canadians want expanded cost reporting, the BIT report notes that people may claim they want more information than they can actually use.
Verch warned of a “point of diminishing returns” when it comes to the amount of information investors receive.
“Let’s not just throw them a lot of information and stuff that they won’t read anyway,” she said. “How do we ensure that customers read what we are required to share? I think that’s where the gap lies.”
Additional disclosures could also increase costs for the industry, which could be passed on to investors.
The BIT reports recommended that firms reduce the “cognitive load” on investors by eliminating information from fee summaries that is unlikely to be useful, and said that firms “should consider carefully before adding further information to fee reports.”
No magic bullet
While disclosure about fees is important, Gross said they will only go so far in educating investors. The vast majority of retail investors are busy with life and will never know much about investing. Total cost reporting won’t be a “magic bullet” that will eliminate the need for other regulations such as professional standards, he said.
BIT expressed a similar view, noting that fee summaries are necessary but not sufficient: investors will still need help deciding how to reduce investment costs.
Verch said many advisors are already doing what will be required under CRM3 and there is no need to wait for reforms to improve reporting. One example is reporting fees and performance on a household versus individual account basis. Most clients prefer the former, she said, and many advisors provide a comprehensive view even though it’s not required.
When it comes to disclosing mutual fund fees, she said advisors should already be doing so before making a trade. Now they can simply inform customers that these fees will (eventually) appear on their annual statement.
When CRM2 went live, Verch said it was “almost a non-event because most advisors were having these conversations anyway.” He suspects this will be the case with CRM3, noting, however, that regulation is still needed to “protect people from a few bad apples.”
Gross would still prefer regulators to act sooner rather than later. There have been numerous delays in the CRM2 reforms, as have newer investor protection measures such as customer-centric reforms and a ban on mutual funds with deferred sales charges.
“Too much damage is caused by waiting too long to resolve these issues,” Gross said, “and in the meantime public confidence in our markets and regulations is undermined.”
How to improve your annual fee reports
- Share the report with your clients as a stand-alone document rather than a simple bank statement.
- Eliminate irrelevant or redundant information, such as fee categories that do not apply to a specific customer.
- Present the most important information in a summary at the beginning of the report.
- Show your account performance from the moment you set it up before short-term results.
- Show your account transactions in a line chart rather than a bar chart.
- Explain indirect fees in plain language and avoid jargon such as “third party compensation.”
- Use illustrations to illustrate the flow of services and payments between investment firms (and advisors), fund managers and investors.
- Use traffic light signage, where goal-oriented behavior (such as paying off high-interest debt) is marked in green and non-goal-oriented behavior (such as unexpected payouts) is marked in red.
- Develop a benchmark that allows investors to compare what similar investors are paying.
- Create an interactive online tool to show how fees affect returns over time.
- Link fees to the actions that cause them, including choices investors have made and advice received.
- Create a script or set of recommended questions that clients can ask advisors about fees.
- Book a call with your customers in advance to discuss fees and performance when sending statements.
Source: 2019 BIT report for OSC and 2019 BEworks report for IFIC
