Can We Finally Empower Investors With Plain English Fund Disclosure?

Given the current polarized political environment, I was thrilled to see a recent example of bipartisanship by the SEC in its announcement of the fund disclosure proposal. The proposal seeks to achieve a laudable goal – to make disclosures for investors easier to understand. While this seems like a common-sense idea, it is revolutionary in many ways and could be a catalyst for a host of innovations that empower investors.

The Streamlined Shareholder Report Is A Win For Investors

The new streamlined shareholder report, of which the SEC gives an example, will show the performance of a hypothetical investment of $10,000 over the past year and the performance of the fund over the past one, five, ten-years. It will also show fund information, such as fund expenses, performance, and material fund changes. The use of visual aids, including graphics, tables, and bulleted lists, are encouraged to make this information more digestible. These reports will replace the numerous and voluminous documents shareholders currently receive, and likely do not read, such as annual prospectuses, holdings, proxy voting information, and credit ratings (much of this information will still be available as before on the firm’s website but will not be sent to investors on a regular basis). This simplification of disclosure could significantly empower investors in their relationships with their financial advisers by making it easier for them to see what expenses they are paying for their investment products.

The Shareholder Report Is A Complement To The CRS

In June of last year, the SEC adopted Form CRS, the client relationship summary, which could assist investors in understanding the trade-offs between a broker and a registered investment adviser (RIA). It does so by explaining the difference between costs for the brokerage side of the house versus the investment adviser side for clients of dual registrants. The shareholder report, together with the client relationship summary (CRS), gives investors a chance to prioritize the tremendous volume of information they receive and focus on the most important elements. Equally important, they will allow third parties to create tools and apps that can help investors compare funds, advisers, brokerage services, and the like.

The SEC Should Go One Step Further And Mandate Fund Portfolio Disclosure

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Together, the CRS and new shareholder report could tell a story of the total fees paid by an investor and what choices the investor might have. For instance, consider an investor who wants to roll over $10K in a 401(k) to an individual retirement account (IRA) with a broker. Assume the investor has a portfolio that consists of four mutual funds, as shown in the table below.

If the investor chooses to work with a broker, the investor may pay transaction fees every time a trade is made. For instance, each fund may have to be repurchased in the IRA account or funds may have to be rebalanced to maintain the same allocation quarterly. Such fees could be $5 or more per trade (or free with certain brokers). On the other hand, the investor could work with an RIA, and pay an asset management fee, which would be a percentage, such as one percent, of the account balance. The RIA would take care of the rebalancing and would have an ongoing duty to monitor the account. The RIA might also suggest different funds with lower expense ratios. A simple comparison of the two scenarios for one year (assuming no change in funds between the two types of accounts) can be seen below.

While the costs look the same in this example, a useful disclosure could inform investors that the costs need not be the same, depending on the services the investor is seeking. For instance, an investor who wants the RIA to choose lower cost funds could end up with a lower asset-weighted expense ratio. The RIA would also handle the trading for the investor, thereby providing an additional service. On the other hand, an investor who is comfortable selecting and trading funds may be better off with a brokerage account.

The information shown above will be discernible through the CRS and new shareholder report summary but will require significant effort on the part of investors. Investors will have to look at all of their shareholder reports to obtain their expense ratios and compute an asset-weighted expense ratio. Investors would have to look at the CRS to determine the trade-offs of a brokerage account versus an RIA. Fortunately, the example on the CRS is also a $10,000 investment, but ride-offs on the fees for brokerage versus RIA-advised accounts may be explained in an abstract narrative form. The most helpful disclosure would be one tailored to the investor’s portfolio showing comparisons, like the one above, across accounts and with different fund selections. Such customization may be overly burdensome for some businesses. At a minimum, an example portfolio could be shown in a fund portfolio disclosure in order to show investors exactly how their choices of accounts and funds aggregate to lead to the total fees they will pay.

The SEC should go one step further than it has in the direction of empowering investors with plain English knowledge by mandating a fund portfolio disclosure that shows investors how an example fund portfolio would compare in terms of fees in a brokerage versus RIA-advised account. In this way, investors could see both the fees they pay for the two types of accounts and how their portfolio might be different in the two accounts because, perhaps, RIA clients have access to different funds than brokerage clients. Even if the same funds are available to all customers, customers could be made aware – through this simple disclosure – that certain fees would not apply if the funds are held through an advised account (e.g., trading fees) and others may be lower because of the expertise of an RIA, e.g., the asset-weighted expense ratio of their portfolio could be lower if the expertise of an RIA is provided to their account. Seeing this fund portfolio-level disclosure would make more obvious to investors both the fees they pay within their funds as well as the trade-offs from the type of account they hold.

Opposition to such a disclosure should be minimal as advisers could use such disclosures to incentivize RIA services over brokerage, while still making brokerage available for those customers for whom it is sufficient. Most importantly, investors will be empowered to deal with the significant informational asymmetries they face in working with financial professionals. They will have information at their fingertips to ask questions about fees and services and what products are available to them at what price, just like they do when shopping for retail products at Walmart or Amazon. Let’s use the SEC’s recent simplification of disclosure through the CRS and the streamlined shareholder report as a beginning – not an end – to the journey for both government and business to finally make it easy for investors to see what they pay when investing their money.

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