Misguided advisers: Are they conflicted or incompetent?
I’ve written several times in the past on the question of why so many advisers continue to recommend expensive, actively managed investment strategies, despite overwhelming evidence that clients would be better off simply buying and holding a diversified portfolio of index funds.
Now a new study from North America sheds new lights on the matter.
Who conducted the research?
The research is published by the Kelley School of Business at Indiana University, in a paper called The Misguided Beliefs of Financial Advisors. It was authored by Juhani Linnainmaa from the University of Southern California, Alessandro Previtero from Indiana University and Brian Melzer from the Federal Reserve Bank of Chicago.
Whom did they survey?
The researchers surveyed 4,000 financial advisers and their clients, all of them from Canada.
What did they find?
The researchers found that, contrary to common perception, it isn’t conflicts of interest that leads advisers to put clients into high-cost, high-turnover, actively managed funds. They tend to invest their own money in the same way and in the same funds and and experience similar drags on investment performance.
The average expense ratios of mutual funds in both advisers’ and clients’ portfolios were very similar, at 2.43% and 2.36% respectively. After adjusting for costs, the researchers found the “net alpha” for both advisers and clients were also similar, at around -3%.
To quote the report:
“Advisers are willing to hold the investments they recommend. Indeed, they invest very similarly to clients, but they have misguided beliefs. Both clients and advisers exhibit trading patterns previously documented for self-directed investors. For example, they purchase funds with better-than-average historical returns and they overwhelmingly favour expensive, actively managed funds. This similarity suggests that advisers do not dramatically alter their recommendations when acting as agents rather than principals.”
What are the implications for policy makers?
The findings suggest that introducing fiduciary rules for financial advisers may not be as effective as some have argued. It may be more beneficial instead to focus on raising levels of competency.
“Regulations that reduce conflicts of interest — by imposing fiduciary duty or banning commissions — do not address misguided beliefs. When advisers recommend strategies that underperform, they act as an agent exactly as they would as a principal, so aligning their interests would not change their behaviour. Solving the problem of misguided beliefs would instead require improved education or screening of advisers.”
You can read the full report here:
ROBIN POWELL is the founder and editor of Adviser 2.0. A freelance journalist, he runs Regis Media, a specialist content marketing consultancy for financial advice firms around the world. You can follow him on Twitter and on LinkedIn.
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