(London, Ont.) — Anybody holding themselves out as financial planner has a fiduciary obligation to educate clients about exchange traded funds and the research that supports their usage, says one planning expert.
The opening speaker at the Institute of Advanced Financial Planners, Shawn Brayman, founder and president of PlanPlus, says there is a global push to professionalize financial planning. With this comes a more stringent fiduciary obligation to disclose conflicts of interest and compensation. Brayman says he would add to these obligations the need to educate clients about the large body of research that suggests ETFs are a cheaper and equally effective investment than actively managed mutual funds.
Brayman highlighted in his presentation that the last decade has seen gross inflation in financial services compensation, to the point that financial services account for 41% of the profits of the U.S. economy. Further, people working in the industry earned on average 181% more than other workers.
“These have been golden days, where guys could go write a CSI course and exam and expect to be paid like a doctor and maybe even call themselves a professional,” Brayman told the audience of Registered Financial Planners from across Canada. “Whether we like it or not, our industry is out of balance. There has to be some adjustments; those adjustments are happening and its right that they are happening.”
The biggest changes are coming to those who call themselves financial planners, Brayman said. In the absence of swift action by government regulators, Brayman says planning associations have proactively worked to create a higher fiduciary burden for those that hold planning credentials.
“If you have a planning designation on your card, you retain a fiduciary duty to the client regardless of what regulation says. You cannot just walk away from it, unless you scratch your designation — [in which case] don’t pretend to be a planner and that’s fine,” Brayman says. “Financial planning was this thing that was married into everything else in the financial services industry. We took a lot of pride trying to create a profession, but plans get done at every level. Fee-based advisors see themselves fighting against guys that are giving [planning] away because they sell products.”
Brayman added, “In most associations, if I asked people how many are paid by asset-based fees, I would expect 99% of the hands to come up in one way or another. The truth of the matter is that even in places like the U.S., with the fee-only association NAPFA (National Association of Personal Financial Advisors), 80% of their members’ compensation are derived by asset management fees and about 20% are derived by fee-for-service.”
Asset management fees that are too high have done much to erode the long-term returns of many client investments, Bayman argued. In his presentation he showed that a Canadian mutual fund portfolio with the common 60% and 40% fixed income allocation had an average 10-year return of 2.4% ending Dec. 31, 2008. The compound management expense ratio during that time was 2.3%.
“If a client had a portfolio of half a million dollars and put it in A-class fee funds — which have an average 2.3% MER, the client would have paid $11,515 in fees a year. If they put the same thing in F-class shares, it would have averaged about 1.24% MER. Which means the client was paying $6,205 at that point,” he says. “If we look at an ETF, the average fee would have been about 0.46% and the client would have paid $2,300 a year, instead of $11,515.
On an advisor class mutual fund, Brayman says there is only a fractional cost to actually be invested in the market.
“To be in the market only cost 20% of fees, 46% of fees are there to indirectly pay the advisor a commission for selling the fund and about a third of it, 34%, was to the fund manager,” he says.
The argument advisors have to make to clients is whether active management is worth this additional cost. He says there is considerable research and academic studies that suggests even if there are examples of active management outperforming over shorter time horizons, it’s virtually impossible to pick those managers beforehand. The longer the time horizon, the more managers start to lag the index.
In Brayman’s opinion, the well-publicized Standard & Poor’s Index Versus Active (SPIVA) does include failed funds in its long-term performance numbers. Fund companies tend to consolidate poorly performing mandates.
“[The SPIVA report] found in Canada after three years it’s just under 15% of managers who outperform the index. Only 12% of active managers are outperforming active managers on a five-year basis,” he says. “I went back to that Morningstar data…to see the how managers did against the index in the 1990s. You’ll see that in the 1990s the managers were all outperforming. This decade they are doing worse.”
He adds, “When I go into Morningstar and look at the fund performance what I’m looking at are the winners.”
Brayman said he didn’t believe he would change the mind of many active management proponents with his view, but he was adamant the merits of passive investment need to be disclosed along the case for choosing mutual funds.
“If I asked how many of you still believe that active management is the right thing to do for your clients I would expect to see a lot of hands go up in the room. What I do believe is that the burden of disclosure is absolutely a requirement of my profession,” he says.
“[I would say to client] I must tell you about this research, even though you may be confused by it, because after I will try to sell you something based on active management. If I was a professional and do not tell you what all the research says, am I really acting in your best interest? Am I taking a fiduciary level of care of working with you? I would say that I am not. It’s hard to tell the truth. I have to tell what the research says.”
(10/02/09)