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Media Backgrounder - Research on Factors that Drive Mutual Fund Flows
Complex Interplay of Factors Drive Mutual Fund Flows
The Investment Funds Institute of Canada (IFIC) has released externally produced research analyzing the factors that influence mutual fund sales. The report, Analysis of the Factors Influencing Sales, Retention and Redemptions of Mutual Fund Units, was written by Investor Economics, an independent research and consulting firm specializing in the financial services sector. It contributes valuable input into current regulatory consideration of mutual fund fees, finding that mutual fund flows are driven by a complex interplay of over 40 factors.
The Investor Economics research, which was completed in September 2015, was conducted at the request of IFIC to complement two Canadian Securities Administrators (CSA) commissioned research reports – the Brondesbury Group’s literature review Mutual Fund Fee Research, and data analysis conducted by Professor Douglas Cumming et.al, A Dissection of Mutual Fund Fees, Flows and Performance. As a matter of courtesy, IFIC and Investor Economics shared the findings with the industry’s regulators and policy makers across the country to give them time to consider the findings before releasing the report more broadly.
Implications of CSA and Investor Economics Fund Fee Research
Taken together, the Investor Economics, Brondesbury Group and Cumming reports provide some insights into the relationships between mutual fund sales, compensation structures and other factors. The research, as a whole, opens questions about how compensation schemes may influence fund sales and redemptions. However, none, due to the limits of their mandates, evaluated sales and redemptions in the context of the investor experience and the additional factors that come into play at the account level (e.g. portfolio diversification, risk tolerance, tax strategies, or the potential trading costs of “chasing performance”).
These reports similarly were not tasked with considering how various compensation schemes may limit or encourage the act of saving by individuals.
- The authors of all three reports acknowledge the limitations of research that relies on aggregated fund data (as did the Cumming and Investor Economics reports and the majority of studies reviewed by Brondesbury). The authors have noted that aggregated fund data cannot provide insights into the impact of compensation structures on account-level performance, wealth accumulation, the ability to meet financial objectives, or other factors related to investor outcomes and the long-term client experience.
- The Investor Economics report states that a definitive examination of the drivers of advisor and investor mutual fund purchasing and disposition decision would require, “a set of matched transactional data, amplified with information regarding individual advisor practice, the composition of the advisor’s product shelf and individual client characteristics.”
- The Brondesbury Group report similarly notes that an ideal study “…would involve comparison of individual clients and advisors over time spans of a few years, with a sample that included clients served through different compensation regimes.”
- Brondesbury also points out that there is no such thing as a “behaviourally neutral compensation scheme” – there is inherent conflict even within fee-based arrangements and no empirical evidence that investors have greater after-fee investment returns with fee-based compensation. The report observes that while removing commissions lowers product cost, advisory fees rise as a means of paying for the cost of service.
- In response to a question raised at the OSC Registrant Outreach Seminar (February 11, 2016), Douglas Cumming agreed that his research could not be used to make conclusions about potential investor outcomes under differing compensation schemes.
IFIC supports the CSA’s approach to research-based decision-making. The three research reports, combined with evidence from international jurisdictions that have made changes to compensation rules, are useful inputs to inform future CSA investigations and decision-making. Other Canadian investor experience research currently underway will also be important, including:
- The British Columbia Securities Commission, on behalf of the CSA, is conducting detailed research aimed at understanding how increased disclosure (Fund Facts and CRM2) may impact investor understanding and decision-making. This long-term research, which is expected to run through to at least 2019, will provide important insights into the effectiveness of cost disclosure in Canada’s unique regulatory and cultural contexts – something that has not been available previously.
- The MFDA is consulting on potential research that would enable it to better understand the geographic, demographic and wealth footprint of the MFDA member client base.
More of this type of account-level research is needed in order to fully understand the implications of potential regulatory interventions in compensation arrangements between investors and advisors. For example:
- Cumming found that fee-based sales are more sensitive to past performance than commission-based sales. However, the reasons for this finding cannot be determined using a fund level analysis. Account-level research would be required to understand whether the sensitivity is a result of fee-based advisors pursuing past performance or whether it’s a result of other factors, e.g., that commission-based accounts are more in line with buy-and-hold investment strategies, such as those typical of pre-authorized contribution plans where set amounts are used to purchase units of a pre-selected mutual fund or a combination of funds.
Highlights of the Investor Economics Findings
The Investor Economics report combines a detailed quantitative analysis of fund sales data over a nine-year period with an exploration of quantitative factors made possible by Investor Economics’ 23-year history observing, measuring and analyzing the mutual fund industry. The report finds that mutual fund flows are driven by a complex interplay of over 40 factors.
Investor Economics found that the primary influencers of fund flows were:
- Investment returns – Individual fund investment returns, expressed in both absolute and relative terms, represent the single most valuable predictor of sales and redemptions at the individual fund level.
- Distribution channel factors – Fund companies with access to affiliated distributors (via direct affiliation or strategic alliance) have experienced, in aggregate, a consistently higher level of net flows than those without access to affiliated distribution.
- External macroeconomic factors – Macro-economic demand factors can overpower all other factors. Asset class flows are strongly influenced by prevailing market conditions. In positive market environments, investors are, overall, more likely to purchase investment products and more likely to invest in higher risk asset classes.
Where trailers were observed to play a role, the impact was not significant when relative fund ratings were taken into account. On a practical level, absolute and relative performance metrics are the measures that are commonly available to advisors and clients and that are crucial to an understanding how advisors and clients decide which funds to buy or redeem.
- Under some circumstances, the level of embedded trailers may exhibit a relationship with fund sales; although relatively high trailer fees seem to play a more significant role in retaining invested assets by improving the funds’ redemption experience.
- Funds with relatively high trailer commissions seem to be held to higher standards by advisors as sales are concentrated in the top quintile funds.
- Macro-economic and fund investment return characteristics override embedded fee compensation levels as the drivers of flows into fund categories and specific funds.
Consistent with its practice for policy-related research, IFIC shared the Investor Economics report with the chairs and staff of the Canadian Securities Administrators as well as finance officials prior to releasing the report publicly.
For further information, contact Sara Clodman, Senior Manager, Public Affairs, firstname.lastname@example.org, 416-309-2306