A U.S. broker’s share of mutual fund loads has a meaningful effect on fund inflows and subsequent return performance, suggests a new study.
The paper, authored by Susan Christoffersen of the Rotman School of Management at the University of Toronto, Richard Evans from the Darden School of Business at the University of Virginia, and David Musto of the Wharton School of Business at the University of Pennsylvania, examined whether the share of fund loads received by brokers in the United States affects fund sales.
Published in the February 2013 issue of Journal of Finance, the study reviewed data filed with the U.S. Securities and Exchange Commission (SEC), which disclosed front-end sales loads and the portion of those sales loads retained by the broker, and whether different shares are paid to captive brokers versus independent brokers.
The study found that, indeed, there are “significant effects of these payments to brokers on funds’ inflows”, particularly when the brokers are independent of the fund manufacturer. Additionally, it finds that the sharing of sales loads is related to subsequent fund performance.
“New investment increases with the load paid to the broker, in particular when the brokers are unaffiliated, and similarly, future performance decreases with the brokers’ payment from the load, particularly when the brokers are unaffiliated,” it finds.
The study didn’t uncover the same relationship between fund performance and revenue sharing arrangements (payments for shelf space) that fund manufacturers and brokers may have. While it observes that the existence of revenue sharing increases new investment, this does not relate significantly to future performance.
The authors concluded that the study’s results indicate a need for greater disclosure in the U.S. fund industry. They say that, while the latitude fund companies have to pay more or less to their brokers has real consequences for their brokers’ clients, this does not mean that the companies should not enjoy this latitude, “though it does argue for letting consumers see the cross section of payments and filtering their brokers’ advice accordingly,” they say.
“Similarly, the stronger evidence for upfront load sharing, as opposed to revenue sharing, as a predictor of poor performance argues for letting consumers know whether broker payments expose the brokers to realized returns,” they add.
The results, which are not directly relevant to the Canadian industry, given the different sales structures of the industry in Canada and the U.S., and different regulatory environments, nevertheless revealed the extent to which broker incentives influence fund sales, and ultimately, investor welfare, which is an ongoing concern for investor advocates and regulators alike.
Late last year, the Canadian Securities Administrators (CSA) published a discussion paper setting out regulatory concerns with the structure of fund fees in Canada, particularly the conflicts that arise from the payment of embedded trailer commissions.
The CSA paper proposed a number of possible options to address those conflicts, including everything from banning trailers to unbundling them, or capping commissions. That paper is out for comment until April 12.