A Lesson in Latin

June 22nd, 2015

Roman coinWhat can Latin –a language that has been dead for centuries– teach us about mutual fund investing. Quite a bit, it turns out.

A report produced by the Brondesbury Group (www.brondesbury.com) sheds light on the issue of compensation for mutual fund sales. The report could have aptly been titled Caveat Emptor, Latin for “Let the buyer beware”.

This report was commissioned by the Ontario Securities Commission on behalf of the Canadian Securities Administration. The report reviews existing research on mutual fund compensation. The objective of the review was “to evaluate the extent to which… the use of….commission based compensation changes the nature of advice and investment outcomes over the longer term”.

Some of their conclusions are as follows:

  • Funds that pay commissions underperform.
  • Mutual fund distribution costs raise expenses and lower investment returns.
  • Advisors push investors into funds that are riskier than appropriate.
  • Compensation influences the flow of money into mutual funds.
  • Higher embedded commissions stimulate sales.
  • Advisors’ recommendations are sometimes biased in favor of alternatives that generate more commission for the advisor.

These conclusions come as no surprise to me. My position continues to be:

  • Compensating distributors by paying commissions is reasonable.
  • Not disclosing the dollar amount of compensation paid by the investor is not reasonable.
  • The issue at the heart of the matter is the value received by the investor for the compensation paid by the investor.
  • The only person who can judge whether the value received is sufficient is the investor.
  • If the investor does not know what they are paying, and most don’t, they are flying blind.

My advice to investors, when sitting across the desk from a person selling you mutual funds, remains:

  • Be aware that the person sitting across from you is a commissioned sales person.
  • Unless the person is a CFA or a CFP, that person is not professionally required to act in your best interests i.e. they do not have a fiduciary duty to you.
  • These rules apply even if you happen to be sitting in a bank at the time.

Caveat Emptor!!