Another Reason to Distrust the Fund Industry

I recently had a chance to interview Ken Kivenko, who runs Canadian Fund Watch and is allied with the Small Investor Protection Association. Ken is a tireless advocate for investors who have been ripped off by the industry, donating his time and money to travel around the country and stare down investment company lawyers who try to intimidate their victims.

Kivenko recently wrote a report outlining his concerns about a new development in the mutual fund industry. The issue is a new point-of-sale disclosure document called “Fund Facts.”

Here’s the quick background. We all know that almost no one reads the entire prospectus of a mutual fund or ETF before they invest. That’s not because we’re lazy. The fact is that the average investor wouldn’t understand most of what he or she was reading anyway. For years, the Canadian Securities Administrators (CSA) has been working to create a brief, easy-to-read, standardized document that would help investors consider the risks, costs and other important features of a fund without having to wade through 40 pages of legalese. Their proposed Fund Facts document “is in plain language, will be no more than two pages and highlights the potential benefits, risks and the costs of investing in a mutual fund.” (To see a sample, go to page 31 of this PDF document.)

It’s an excellent idea, and it would serve investors well if it were done properly. Unfortunately, Kivenko says the proposed format is full of flaws. Notably:

  • The Fund Facts document describes a fund’s risk with a single word or phrase: very low, low, low to moderate, moderate, moderate to high, or high. “The fund company gets to decide on how to define risk,” Kivenko’s report says. “You can imagine how this will mislead investors.” For example, a fund that invests 100% in equities could be defined as “moderate” risk, even though any equity fund can lose 30% or 40% in a single year.
  • Fund companies need to disclose the performance of the fund over the last 10 years, but the data have no context. No index benchmark is used, and there’s no mention of how the average fund in the category performed. This is basic information that even Morningstar includes. “By not requiring such information in the Fund Facts, the CSA implicitly assumes that most investors already know or do not need this information,” says the report. “Academic research does not support this assumption.”
  • The description of a fund’s suitability is unhelpful. “Fund Facts boils suitability down to vague descriptions,” Kivenko writes. For example, the document may describe a fund as “a long-term investment,” without specifying whether that means five years or 20 years. Another standard label warns investors not to buy the fund “if you need steady source of income.” Kivenko worries this label may “may send the unintended message that stock funds have no place in the context of income-oriented portfolios.”

FAIR Canada has published its own list of concerns, and calls for the fund’s costs to be front-and-centre in the Fund Facts document, instead of on page two: “Given the potential impact of fees on an investor’s total returns, we believe that the section entitled ‘How much does it cost?’ should precede the section entitled ‘How has the fund performed?’”

Despite the serious concerns of these investor advocates, the CSA has decided to press on with its flawed proposal. They plan to publish the Fund Facts requirements in December, and by mid-2011 advisors will likely be handing the two-pager to their clients.

“For our part,” Kivenko writes, “we are still trying to contact regulators in an attempt to dissuade them from unleashing this toxic regulation on unsuspecting Main Street investors. In the meantime, caveat emptor.”

 

6 Responses to Another Reason to Distrust the Fund Industry

  1. Marz July 19, 2010 at 9:26 am #

    But the fund facts (from your example) look so pretty! Surely something so clean and organized is also trustworthy! IT EVEN HAS PIE CHARTS!

  2. Warren MacKenzie July 20, 2010 at 9:39 am #

    Another problem is that all this talk diverts attention from a more serious problem which is that investors think they are dealing with a fiduciary who puts a client’s interest ahead of his own – and in fact they are dealing with a salesperson.

  3. Financial Cents July 20, 2010 at 10:18 am #

    Who doesn’t like pretty charts and graphs? 🙂 Words like this never sound good to me….”Despite the serious concerns of these investor advocates, the CSA has decided to press on with its flawed proposal.” Nothing good can come of that. Good post Dan.

  4. Bruce Loeppky July 20, 2010 at 1:32 pm #

    I agree that the proposed Fund Facts document could be done better & most of Ken’s suggestions are valid.I also agree that most prospectuses don’t get read because of the length & legalese.I find Warren’s comment quite offensive in that he seems to be painting all financial advisors with the same brush.I invest almost all client assets in Front End 0% whereas I could easily convince most clients to invest in DSC funds which would pay me more(but esssentially lock client into fund company for 6-7 years unless they paid managmnent fees to get out).We are already working in a complicated industry & misleading comments such as those don’t help anybody.

  5. Canadian Couch Potato July 20, 2010 at 4:17 pm #

    @Bruce: Do your clients pay advisory fees directly to you? I think most of us would agree that this compensation model is more transparent and less conflicted than the usual practice of burying these fees in the fund costs.

    I don’t think any reasonable person would paint all advisors with the same brush. Unfortunately, even honest and conscientious advisors may have their hands tied by firms that only allow them sell a limited inventory of high-fee funds.

  6. Canadian Couch Potato July 21, 2010 at 1:07 am #

    Gail Bebee has suggested the following sliding risk scale that could be used in the Fund Facts document. It’s based on the worst 12-month return ever posted by the fund:

    Low: >0%
    Medium Low: 0% to -10%
    Medium: -10% to -20%
    Medium High: -20% to -30%
    High: More than -30%

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