Does the investment industry have an uneasy relationship with disclosure?

An investor advocate tells WP why many investors don't how much they’re paying for investment management

Does the investment industry have an uneasy relationship with disclosure?

In this guest article, investor advocate Ken Kivenko explains why many investors do not know how much they’re paying for investment management.

"The primary purpose of disclosure is to help retail investors assess the risks and returns associated with an offer and make informed investment decisions.

Disclosure can also involve revealing the relationship between a “advisor" and investor, conflicts-of-interest and of course product and account fees. There are statutory disclosures and there are industry marketing and sales disclosures. The composite of these disclosures is virtually a mine field for the retail investor. The investment industry maintains that the disclosure system works well. Investor advocates claim that much improvement is needed. Historically, the investment industry has had an uneasy relationship with disclosure.

More than $1.4 trillion is invested in mutual funds. Mutual fund investors flock to funds with high past returns, despite there being little, if any, relationship between high past returns and high future returns. Because fund management fees are based on the amount of assets invested in their funds, however, fund companies regularly advertise the returns of their high-performing funds. The CSA requires these advertisements to contain a disclaimer warning that past returns do not guarantee future returns and that investors could lose money in the funds.

Despite arguing for years that the standard mutual fund disclaimer was ineffective in warning retail investors of the risks in mutual fund investing (which is backed up by independent research), the same text remains in place a decade after it was first discovered that the disclaimer neither reduces investors' propensity to invest in advertised funds nor diminishes their expectations regarding the funds' future returns. Of course, it didn't help that the ads had the warning in small font in white over a grey background at the bottom of an ad.

When regulators wanted better mutual fund disclosure , the industry bundled a package of "simplified prospectuses" together into a massive document which history shows was ineffective disclosure, and ultimately led to even more simplified disclosure via Fund Facts .This may have been one of the first industry applications of behavioural finance.

Back in 2006, a key mutual fund disclosure was removed from public access - The Statement of Portfolio Transactions (SPT). At the time, respected fund analyst Dan Hallett observed: “The previously invaluable Statement of Portfolio Transactions (SPT) has yielded to the MRFP's much less useful information package, which includes top 25 holdings and commentary that is scrubbed heavily by lawyers. The importance of the SPT cannot be overstated.”

Hallett continued: “The document I had considered most important in helping confirm what portfolio managers actually do - as opposed to what they say -- is gone. I will continue to find ways around the lack of certain information. However, it's a sad surprise when a long-standing disclosure document is yanked from the available information set.”

When regulators wanted Canadian funds to follow the US example of providing proxy voting records the industry panned the idea. Numerous Canadian mutual fund managers opposed to detailing how they vote on shareholder issues, saying operating costs will rise and there is no demand for the information.

The fund industry has for years used "free lunch" seminars to, believe it or not, “educate” investors. Independent research has found these educational seminars to in fact be sales initiatives often accompanied by incomplete or inaccurate disclosures. Celebrity speakers used to be brought in to ratify the value of the product but regulatory scrutiny has all but killed off the cheesy practice.

After the OSC FDM proposal was killed off by regulators and industry participants in 2004, a decade later we saw CRM2, an initiative on better cost and performance disclosure. Fee disclosure is so complex that most investors don't really know what their investments cost them. After 12 years of consultations CRM2 was made a regulation but the fees disclosed are only those paid to the dealer and exclude other fees such as fund management fees, DSC early redemption payments and fund brokerage expenses (TER). Asset management fees are usually more than half of the MER, so it accounts for the majority of investor expenses.

Investors may be less aware of how much they're actually paying for investment management rather than advice.

While the new advisor-fee disclosure rules are a positive step in favour of investors, mutual fund companies have managed to avoid greater disclosure. The report is issued annually rather than shown on monthly account statements. The industry now says this needs to be corrected. It could be another 5-10 years before this occurs."

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