Are conflicts of interest really the root of market-lagging advice?

For over a decade, Canadian advisors were just as misguided as the clients they helped

Are conflicts of interest really the root of market-lagging advice?

Many of the best financial advisors follow one golden rule: treat your client’s portfolios as if they were your own. Unfortunately, it turns out, that approach isn’t always helpful — and could be downright detrimental.

In a new academic study called The Misguided Beliefs of Financial Advisers, researchers looked at the portfolio histories of more than 500,000 clients at either of two large Canadian financial institutions from 1999 until 2013. They also looked at the portfolio histories of the approximately 4,000 advisors who worked with those investors over the same period.

Indiana university finance professor Alessandro Preyitero, one of the researchers, told MarketWatch that Canadian investment advisors face conflicts of interest because of high investing fees. So if those conflicts played a role in bad advice, there should be significant differences between advisors’ portfolios and those of their clients.

However, the advisors and clients seemed to get caught in the same investing traps. For example, advisors recommended mutual funds with an average expense ratio of 2.36% to their clients; in their own portfolios, the average expense ratio was even higher at 2.43%, and they continued to invest in expensive mutual funds even after leaving the industry.

“The researchers reached the same conclusions when analyzing high portfolio turnover, which skeptics previously have associated with adviser conflicts of interest,” MarketWatch said. They found that portfolio turnover for advisors was just as high as that of clients, even after the advisors left the industry.

And when it came to performance, advisors and clients saw almost identical returns: about 3% below that of a buy-and-hold strategy.

The results suggest that, at least for a time, conflicts of interest didn’t play a role when investors saw market-lagging returns. The problem seemed to be an honest misconception that high-fee mutual funds and frequent trading were key to investing success.

But things have likely changed since then. After all, with the rise of ETFs and other market-tracking instruments, investors and advisors have gotten wise to the potential impact of fees on portfolio returns.