Fewer than one in four Canadians understands the costs of investing based on standard fee summaries, suggesting that cost reporting for investment fund charges should be expanded, the Mutual Fund Dealers Association of Canada (MFDA) says.
The self-regulatory organization released a report Monday prepared by U.K.-based behavioural economics firm Behavioural Insights Team.
While more than two-thirds of Canadian investors review portions of their fee summaries, most don’t come away with a strong understanding of what they’re actually paying, the report found.
“In a rigorous experiment, we found that only 23% of investors correctly identified their total cost of investing when they were given a status quo fee summary with an additional disclosure that some fees were not included,” the report said.
“Overall, we found that expanded cost reporting that specifies investment fund charges can significantly increase investors’ understanding of their cost of investing.”
The MFDA has looked at expanding the fee summaries required under the Client Relationship Model (CRM2) to include costs related to the management and operation of investment funds. The organization published a consultation paper on the topic in 2018.
Monday’s report looks to behavioural science for ideas about how additional reporting should look.
The report said most investors struggle to understand their investing costs, with more than four in five failing to identify the types of costs included in their fee summaries.
“Even experienced investors struggle to understand key terms and how their choices influence the type and amount of fees they pay,” the report said.
The report blamed the low level of comprehension on “the inherent complexity of investment fees and how they relate to investor choices” but also behavioural factors such as limited attention, disengagement when faced with complex information, and the tendency to neglect relatively small amounts — including the “exponential growth of the impact of fees over time.”
It also found that the limited reporting requirements limit investor education. In an experiment testing three cost reporting formats in addition to the existing framework, the authors found that the three formats that included investment fund charges increased investor comprehension relative to the status quo.
“We found that providing a short preamble noting the impact of fees, consolidating amounts paid to dealers and to investment fund companies in a single table, and more clearly defining key terms can increase investor comprehension,” the report said.
“We further found that defining fees directly in the cost of investing table and explicitly linking fees to investor actions may further facilitate comprehension.”
The results suggested that including the management expense ratio (MER) for each fund within the account holdings section of account statements doesn’t improve overall comprehension of the annual fee summaries. However, the report said that showing the MER may help investors identify certain actions to reduce their cost of investing or to improve the value of the service they receive. For this reason, including the MER in summaries “may have a small positive impact on investor comprehension.”
The MFDA said the research supports regulatory proposals to expand cost reporting to include investment fund charges. The fee summaries should clarify certain terms, make key information more salient and “describe fees in ways that help investors understand which choices engendered those fees.”
The report also noted the limits of additional reporting. Fee summaries are necessary but insufficient, it said, and not a panacea. Investors will still need help deciding how to reduce investing costs.
It also warned against overloading investors with information. While survey data indicate that Canadians want expanded cost reporting, the report noted that people may say they want more information than they can actually use.
Behavioural Insights Team also conducted research for the Ontario Securities Commission on CRM2 in 2019, which found investors don’t understand what they’re paying or what to do about it.