This article appears in the March 2022 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.
It’s been five years since clients received their first annual reports outlining investment fees and performance under the client relationship model reforms (CRM2), and evidence is mounting that the disclosures aren’t working.
Studies have found that few investors can identify their total cost of investing or the types of costs included in their fee summaries. Many clients are confused by common industry terms such as commissions, or by the distinction between investment fund managers and dealers.
“Is it working?” asked Sybil Verch, head of private client solutions with Raymond James in Vancouver. “Here we are five years later. Did we accomplish what we set out to accomplish? I think the answer is no.”
What regulators hoped to accomplish with the reforms was to improve investors’ understanding of the fees they pay. Neil Gross, chairman of the Ontario Securities Commission’s (OSC) Investor Advisory Panel, said CRM2 “hasn’t really moved the needle.”
“CRM2 was never a perfect solution to the problem of making unsophisticated investors aware of the costs they were incurring with investments,” Gross said.
In fact, by focusing only on money paid for the advice component of investing and leaving out fees paid to investment fund managers, Gross said the disclosures may have accidentally led some investors to believe their fees are less than what they’re actually paying.
Even before CRM2 took effect, discussion in the industry was moving toward total cost reporting that includes fund fees. With the Canadian Securities Administrators preparing to release CRM3 proposals to harmonize and enhance cost disclosure for both mutual funds and segregated funds this year, experts say the way information is presented in fee statements is at least as important as what information is included. And far from being fearful about additional disclosures, advisors should see the statements as an opportunity to build trust with skeptical clients.
How are we doing so far?
The CRM2 reforms took effect in July 2016, giving firms one year to provide clients with their first reports outlining investment performance and the fees paid to the dealer firm.
Since the changes came into force, the industry has been tracking investors’ comprehension. For the most part, results aren’t encouraging.
The Investment Fund Institute of Canada’s (IFIC) annual investor insights survey shows little progress since 2017 in clients’ understanding of fees based on their annual statements. In its 2020 poll (the most recent at press time), only about half of clients said statements clearly showed the fees paid to their advisor’s firm; almost one in four gave the statements a “poor” rating in that category. More respondents said in 2017 that the statements were easy to understand than in 2020.
The Behavioural Insights Team (BIT), a U.K.-based consulting firm, produced reports about CRM2 for the OSC in 2019 and for the Mutual Fund Dealers Association of Canada (MFDA) in 2021. BIT found that fewer than one in five investors could identify the types of costs included in their fee summaries, and that there’s a lot of confusion around embedded compensation, such as trailer fees. Many investors didn’t understand that the reports only show fees paid to their dealer and don’t include the product costs.
An audit of CRM2 reports submitted by IFIC dealer members found the statements contained jargon and technical language, and included text at the reading level of a college graduate — much higher than what’s required for investor comprehension.
More is more
The BIT study for the MFDA found investors want expanded cost reporting and that adding fund fees to statements improved their comprehension. But how the information is presented will be crucial.
Toronto-based consulting firm BEworks, which conducted the study for IFIC, found that using simple language, chunking thematic information and eliminating jargon could improve clients’ comprehension (see “How to improve annual fee reports” below). IFIC is working on an updated model statement that implements some of the findings from the BEworks research.
David Lewis, president of the BEworks Research Institute, said that while the annual statements are a snapshot of the past, they should be presented with a future orientation. That means showing a client’s performance and fees in the context of their investment objectives so they understand the action needed to reach their goals.
“Full-unit framing” should show how fees, market performance and portfolio contributions relate, he said, and linking a client’s goals to their behaviour provides context and incentive for clients to read their statements.
“If people understand all those things and how they fit together, they’ll be more trusting,” said Lewis, a recently appointed OSC commissioner. (He spoke to AE as a behavioural expert and his views don’t necessarily represent the commission’s.) “Many times, the client’s fear is worse than reality.”
A common industry concern is that total cost reporting would overwhelm clients or make them focus on investment costs at the expense of other factors. But Lewis said if fees are presented in an appropriate way, “it doesn’t make clients more price sensitive — it actually does the opposite. It makes them more trusting and more willing to listen to advice.”
BIT said the amounts paid to dealers and to investment fund companies should appear in a single table, and that firms should provide a short preamble noting the impact of fees and clearly defining terms.
While regulation has trended toward principle-based rather than prescriptive rules, Gross said, he hopes that with CRM3 “we’ll see regulators specify, carefully, the manner in which the information is to be presented.” Part of CRM2’s ineffectiveness owes to regulators not mandating the statements’ presentation, he said.
The BEworks survey of IFIC dealer members’ statements found CRM2 reports varied in length from two to 20 pages.
“Where the regulation does not prescribe an effective method of presentation and leaves it to industry to present the information in whatever manner they choose, it may not — and often apparently is not — getting presented in an effective manner,” Gross said.
The OSC Investor Advisory Panel that Gross heads made the case that statements should go beyond reporting annual fees and show the effect of long-term fee compounding. “Few investors realize that 1% or 2% annual fees can, over the long term, consume 25%–50% of their total investment returns,” the panel’s response to the MFDA’s 2018 CRM3 discussion paper said.
Warning: Cognitive overload
Experts also warned against overloading investors with information. While survey data indicates that Canadians want expanded cost reporting, the BIT report noted that people may say 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 a bunch more information at them and more things that they won’t read,” she said. “How do we ensure that clients read what it is we’re required to share? I think that’s where the gap is.”
Additional disclosure could also increase costs for the industry, which could be transferred to investors.
The BIT reports recommended firms reduce the “cognitive load” on investors by eliminating information from the fee summary that’s unlikely to be useful, and said firms “should think carefully before adding further information to fee reports.”
No magic bullet
While fee disclosures are important, Gross said they’ll only go so far in educating investors. The vast majority of retail investors are busy living their lives and won’t ever be very knowledgeable about investing. Total cost reporting won’t be a “magic bullet” that eliminates the need for other regulation such as professional standards, he said.
BIT made a similar point, noting that fee summaries are necessary but insufficient: investors will still need help deciding how to reduce investing costs.
Verch said a lot of advisors are already doing what will be required under CRM3, and there’s no need to wait for the reforms to improve statements. One example is providing fees and performance on a household basis versus account by account. Most clients prefer the former, she said, and many advisors are providing an all-in-one picture, even though it’s not required.
As for disclosing investment fund fees, she said advisors should already be doing this before making trades. Now they can simply let clients know those charges will (eventually) appear on their annual statements.
When CRM2 came into force, Verch said it was “almost a non-event, because the majority of advisors were having those conversations anyway.” She suspects that will be the case again with CRM3, while noting regulation is still needed to “protect people from the few bad apples out there.”
Gross would still like to see regulators act sooner than later. The CRM2 reforms saw numerous delays, as have more recent investor protection measures such as the client-focused reforms and the ban of mutual funds with deferred sales charges.
“Too much harm occurs waiting for a resolution of these issues over long periods of time,” Gross said, “and in the meantime, public confidence in our markets and regulation gets damaged.”
How to improve annual fee reports
- Provide the report to clients as a stand-alone document, rather than with a regular account statement.
- Eliminate non-essential or redundant information, such as categories of fees that don’t apply to a particular client.
- Present the essential information in a summary at the beginning of the report.
- Show account performance since inception before short-term performance.
- Show account transactions in a line graph, not a bar graph.
- Explain indirect charges in plain language and avoid jargon like “third-party compensation.”
- Use illustrations to depict the flow of services and payment between investment firms (and advisors), fund managers
- Use traffic-light labelling, where goal-aligned behaviour (such as paying down high-interest debt) appears as green and non-goal-aligned behaviour (such as unexpected withdrawals) as red.
- Develop a benchmark that allows investors to compare what similar investors pay.
- Create an interactive online tool to show how fees affect returns over time.
- Link fees to the actions that trigger them, including the choices investors made and the advice received.
- Create a script or set of recommended questions clients can ask advisors about fees.
- Pre-book a call with clients to discuss fees and performance when sending out the
Source: BIT’s 2019 report for the OSC and BEworks’ 2019 report for IFIC