At Marketwatch, Jonathan Burton interviews shareholder advocate Mercer Bullard, the founder of Fund Democracy and now an Assistant Professor at the University of Mississippi School of Law.
After a discussion of independent boards at mutual funds, Burton turns to what Bullard has called the "broker penalty." That's where we join this important conversation.
MarketWatch: You've also focused on brokers who put clients into costly mutual funds when cheaper options were available. How serious is this "broker penalty," as you call it, that some investors apparently wind up paying?
Bullard: At the margins you will have brokers who are not providing the most efficient advice to their clients because they have an economic incentive not to do so. We did a study intended to isolate this conflict of interest. We chose index funds, which are essentially a commodity; matching the Standard & Poor's 500 is the same no matter what fund you invest in.
We didn't look at compensation paid to the broker. Maybe you're paying too much, but once you've paid the broker for the advice, what is the cost of this generic product he sells you? If this were a logical system, if you've paid more to get advice, the broker should be selling you or directing you to the low-cost S&P 500 Index fund.
What happened instead was people got exactly the opposite advice. First, you pay the broker for the advice, and then you get bad advice that leads you to invest in the higher cost fund. In a sense you pay for advice and then get penalized for the advice.MarketWatch: How can fund investors cut a better deal with brokers and financial advisers?
Bullard: Find a broker who is going to put you in an asset-based fee program. Although I still think you are probably going to pay too much, at least you will get a benefit in that the broker has incentive to put you in the lowest-cost S&P 500 fund, or if it's an actively managed fund, to find you one that is going to perform the best.
Why is that? Because the greater the growth in the fund the broker recommends, the bigger the broker's fee. It aligns your interest with the broker's. You both want to see the account grow, and the broker isn't getting any side payments in any form.The problem is you need that disclosure to be made explicitly, and you actually have to ask for it because brokers who are providing you personalized investment advice don't have to be treated as if they're a fiduciary who must disclose to you all their conflicts of interest. These brokers, no matter how personalized the investment advice, can be treated as salespeople who have no obligation to disclose those kinds of conflicts. [Emphasis added]
Bullard is right, and his distinction between brokers (who are salespeople) and Registered Investment Advisors (who are legal fiduciaries) is both hugely important and badly underappreciated. Investors who understand the far-reaching implications of Bullard's argument will be better-prepared to look out for their own interests.
We'll be writing more on the matter of paying for financial help in upcoming posts.
Source
Jonathan Burton, "Holding Mutual Funds to the Fire: Investor Advocate Mercer Bullard on Independent Boards and Greedy Brokers," Marketwatch, March 26, 2007