Clients who buy mutual funds based on recommendations of advisors may find themselves, on average, worse off than do-it-yourself investors, says a recent U.S. study.

The examination of advisor behaviour by three U.S. academics — including Harvard professor Peter Tufano, who created the fuss about mutual fund fees — shows that advisor-recommended fund portfolios generally underperform what most people do on their own if they don’t have advisors. The study suggests that when it comes to actual fund investing, advisors in the U.S. add little or no value.

This flies in the face of what advisors everywhere strive to do in the fund-investing process — dissuade clients from asset-shrinking behaviours such as poor risk assessment, market-timing and chasing one-hit wonders or the flavour of the month. Some Canadian experts, such as Dan Richards, president of consulting firm Strategic Imperatives Ltd. in Toronto, question whether the study’s findings are applicable to the Canadian market, which has significant differences from the U.S. market.

Nonetheless, the study suggests that those giving advice may be just as susceptible to making investing errors as everybody else.

Assessing the Cost and Benefit of Brokers in the Mutual Fund In-dustry, written by Tufano, Harvard colleague Daniel Berg-stresser and University of Oregon professor John Chambers, compares the costs and performance of more than 4,000 mutual funds offered in the U.S. — some sold by advisors, some selected by self-directed investors — from 1996 to 2002. The funds under review held almost US$4 trillion in assets, with two-thirds of those assets held in a variety of offerings sold through advisors.

Hoping to quantify advisors’ con-tributions to their clients’ financial well-being, the authors looked at whether advisors might be better at helping clients select funds that are harder to find or evaluate, gain access to funds with lower costs (excluding distribution costs), pick better-performing funds, provide superior asset allocation and protect them from behavioural biases.

The results are anything but flattering, highlighting what the researchers label as “significant shortcomings” among advisors.

Comparing weighted average returns, net of all fees except charges paid up front or upon redemption, advisor-sold equity funds had an average annual compound return that was roughly half that of equity funds purchased directly, the professors report.

Even before accounting for distribution expenses, the underperformance of advisor-sold funds relative to those sold through the direct channel adds up to approximately US$9 billion a year, the authors say.

However, they do “remain open to the possibility that substantial intangible benefits exist” when considering the broader relationships advisors and clients enjoy. But these are both hard to quantify and to track, they add.

It’s quite possible, they concede, that there is considerable value in persuading risk-averse clients to invest for the long term and aim for higher returns than they would otherwise. And the study did find that advisors frequently directed clients to funds that would be harder for an amateur to find and analyse, and that advisors persuaded these clients to diversify, including internationally, which would have paid off more often than not. But when it actually comes to delivering bottom-line performance results, the jury on advisors’ overall contribution is still out, the professors maintain.

For example, the study found that U.S. advisors recommended a disproportionate amount of low-risk, low-return money market funds. As well, clients not only paid extra for advice; the funds they bought often had higher fees. What’s worse, in looking at typical advisor-sponsored clients compared with direct fund purchasers, the authors conclude the recommendations on the allocation of assets from advisors were no better than anybody else’s and that advisors were just as likely to get excited and chase trends as the clients they were advising.

Does this mean it’s time for advisors to turn out the lights?

Not in the least, say industry observers.

It’s important to realize that this study focuses on U.S. investors who buy mutual funds directly or through no-load fund supermarkets, says Richards: “This is only a subset of the marketplace, and — in Canada, at least — a very small one. It’s a bit of a reach to make such sweeping statements at this stage.”

Neither does Richards view mutual fund buyers as a group as the correct proxy for the self-directed market. “Include results from discount brokers, for instance, and you’ll see a different pattern,” he says. “At least, that’s what other such studies have indicated.”

@page_break@(Earlier this year, Tufano and another group of colleagues published a study suggesting, among other things, that Canadian mutual funds are by far the most expensive in the developed world. That paper has been widely criticized for its inconsistent methodology and sweeping conclusions, prompting prominent fund analyst Dan Hallett, president of Windsor, Ont.-based Dan Hallett & Associates Inc. , to recommend the authors review their numbers and conclusions.)

The debate ranges on, so much so that the researchers on the first study recently said that they are reviewing their estimates of average fees in Canada to take into account differences in fund size and other variables.

Methodology aside, the paper on independent fund returns vs advisor selection also flies in the face of other studies and anecdotal reports, Richards says.

“Our research, as well as several independent studies, suggests that most self-directed investors end up with imbalanced portfolios and are subsequently disappointed in their returns,” says Richards. Also, from an advisor’s point of view, performance should not be the key element in the client equation, he believes.

“It might be a point of differentiation for those that have a talent for picking stocks and building portfolios,” he says. “Traditionally, though, successful advisors have been better at relationship-building than investment management. It’s a rare advisor who has the talent and discipline to do all things well.”

Adrian Mastracci, president of KCM Wealth Management Inc. in Vancouver, agrees. The client who stays a client is one who understands and appreciates both the quality of advice that professionals provide and the value of the advice itself. “The investment component within a true wealth-management relationship is actually quite small,” he says. “For the researchers to describe risk profiling, [and] tax, estate and business planning as ‘intangibles’ shows a fundamental lack of understanding of the client/advisor rapport.”

Client needs, for example, may well have dictated a higher cash component or more conservative choices. Damning advisors this way seems equally inconsistent. “Our job is helping clients define and realize their goals, not to try to help them beat the benchmark every year,” Mastracci says. ”We should be creating reasonable expectations, managing risk and let investment performance take its appropriate course.”

Nonetheless, says Dr. Donald Moine, a behavioural research scientist and Chicago-based Morningstar Research Inc. columnist specializing in persuasion training and advisor development, studies such as this “will strengthen our profession and improve the results we deliver to clients. For much too long, some advisors have been engaging in investment practices that provide minimal or non-existent benefit to clients.”

The Harvard study also found that the clients of U.S. advisors are less educated and have lower net worth than do-it-yourself investors. Moine worries about an exodus of bright, high-income clients who may decide to buy low-cost index funds on their own.

But Richards disagrees. “Com-petent advisors are delivering a premium product in a marketplace full of lower-cost alternatives,” he says. “The affluent aren’t looking to delegate responsibility completely. Most of them are looking for professional partners — to work with them rather than for them.

“To position yourself as that partner, start by making your relationship clear to the client,” he tells advisors, reiterating that the discussion should not be limited to investment performance.

Despite this, Moine maintains, “Clients and prospects will never see us in the same light again.”

But, with more work on client relationships, he adds, advisors actually “stand to be a beneficiary rather than a victim of this massive sea change in perception.” IE