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Conflict of interest for investment advisors and their clients

Conflict of interest for investment advisors and their clients

May 7, 2015

Fist bumpFinancial advisors and their clients are on a collision course. The priorities of the two groups are too often diametrically opposed. 

A perfect business relationship occurs when the goals of both participants are aligned. Goal congruence is a lovely thing. Both sides going in the same direction. These relationships are built to last. 

The basis for this column comes from two separate events. A group of investors expressed their concerns and a group of financial advisors expressed theirs. 

The first instance occurred when a young mutual fund sales person who was new in the business had his investment recommendations for a hypothetical client published in a national newspaper. He worked at a firm that primarily sold their own mutual funds. 

He recommended actively managed mutual funds that would be sold with the salesperson receiving a sales commission because those funds are sold with a Deferred Sales Charge. 

An actively managed fund means the mutual fund investment manager would select what stocks the fund would purchase and when those securities would be bought and sold. There is significant evidence that this investment strategy does not produce superior results to passive and cheaper funds. 

The evidence is from both academic research done over the last 50 years plus investment performance results published by Standard and Poor’s and many others. Bottom line is actively managed accounts do not produce superior results. 

The Deferred Sales Charge sales option means there is a sales commission paid usually in the amount of 5 per cent of the value of the investment. So on a $100,000 investment the sales commission is $5,000. 

Then the client must leave the funds invested with that mutual fund for a period of time that usually is seven years or pay an exit cost to the mutual fund company. The exit charge is often 7 per cent in year one and declines slowly over seven years. 

The public outcry from readers was severe. They scolded the salesperson in their response to the newspaper for both the recommendation of actively invested mutual funds and the Deferred Sales Charge option that paid a large sales commission while effectively locking the money in for seven years.

Again may we repeat the criticism was severe. Fast forward and the outcome was the business school graduate salesperson studied investments and saw the evidence of what concerned the irate readers. 

The positive outcome was he left that company and joined a very respected firm that fully understood the evidence of investing and has a sound investment strategy that is far better for the client. Better investment logic with zero commissions on the sale of any funds. 

The second story is about a meeting hosted by the Ontario Securities Commission with 150 financial advisors. The OSC was getting industry participant feedback on proposed regulations that would transform the investment business into a more transparent process. 

Under the newly proposed rules clients would have to be told what commission the advisors are being paid. The amount of commission was not being regulated but just the amount of commission being paid had to be disclosed. 

We spoke with someone who was at that meeting and he described it as crazy and a mob scene. Financial advisors were lined up at the microphone and all strongly expressed their disgust at this commission disclosure requirement. 

There were derogatory comments made about a well known journalist for continuing to write about the need to reform the investment business. The journalist’s writings were completely in line with the feedback our business school graduate received from irate readers about his suggestion to sell hidden commission funds. 

This has the makings of a big fight. In one corner are investors expressing their opinion against actively managed mutual funds being sold with large and hidden sales commissions. 

In the other corner the vocal outcry of mutual fund salespeople who want to protect their livelihood. They want to continue to earn large commissions without that information being shared with their clients. 

Two opposite views. Both sides are strongly passionate about their beliefs.

That is a description of an industry that is broken. These types of broken industries are ripe for entrepreneurs to rise up and harness the consumers cry for change by offering investors a financial services platform based on the needs of the clients. 

Clients want and can expect to receive sound investment strategies based on fair fees that are fully transparent. In our opinion the client’s interests will eventually prevail. 

The investment industry must change. More clients should be vocal in their objection to the status quo and push their advisor to change the way they do business.