Does a fiduciary standard maximize social welfare?

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GuyLafleur
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Does a fiduciary standard maximize social welfare?

Post by GuyLafleur »

I've been reading about how regulators are thinking of introducing a rule that says brokers will have to act in the best interests of their clients, instead of merely choosing suitable investments.

For those of you interested in macroeconomics, do you think that introducing a fiduciary rule actually maximizes social welfare? I was having a conversation with a friend who majored in economics and he said that he thinks that allowing brokers to recommend higher-fee options under the current suitability standard does not actually result in a net loss to social welfare because it is merely a re-distribution from the consumer's pocket to the intermediary's pocket. What are your takes? If brokers were incentivized by a Fiduciary Rule to recommend investment funds which resulted in higher risk-adjusted returns for clients, with the trade-off being that brokers collect less in fees and commissions, would this result in total net gain to social welfare, or would it just be a wash?
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Re: Does a fiduciary standard maximize social welfare?

Post by NorthernRaven »

You've packed in a giant assumption there, that "net social welfare" is something definable and good. Does this mean that "10 people in grinding poverty, and one enormously wealthy person" is the same as "11 people with some reasonable standard of living"? I'm not sure this is what most people would use to measure proposed public policy.

In this case, the fiduciary discussion is much more "should government regulate in a case where market share, consumer inertia and asymmetrical knowledge provide an opportunity for financial firms to have big fat margins"? The answer will vary depending on one's economic and political viewpoints.
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kcowan
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Re: Does a fiduciary standard maximize social welfare?

Post by kcowan »

I have come to think of financial advice to be like big pharma. We do not expect the pharma companies to act in the best interest of consumers. Why would we expect the FA community to be any different.
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Re: Does a fiduciary standard maximize social welfare?

Post by SQRT »

kcowan wrote:I have come to think of financial advice to be like big pharma. We do not expect the pharma companies to act in the best interest of consumers. Why would we expect the FA community to be any different.
Or telcos, banks, grocery stores, etc. Ya gotta look after yourself mostly. On the surface, a feduciary duty sounds good but I would think the advisors would have so many weasel words and client waivers, etc that it might be difficult to enforce or interpret.

To the OP. I think your friend is too caught up in his course and the theory behind it. Unearned and possibly unfair transfers from one party to another may not decrease total wellbeing in our society but are still nevertheless worth stopping. If a poor thief steals money from a rich person, economic wellbeing may be increased but that doesn't mean we should encourage it.
Last edited by SQRT on 30 Nov 2016 05:25, edited 1 time in total.
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ghariton
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Re: Does a fiduciary standard maximize social welfare?

Post by ghariton »

GuyLafleur wrote:For those of you interested in macroeconomics, do you think that introducing a fiduciary rule actually maximizes social welfare?
It doesn't maximize social welfare, but it does increase it. There are several reasons:

(1) If I can trust my adviser to have my best interests as priority, I can afford to do less independent research and generally checking up on him, thus saving society's resources. And with trust comes more willingness to invest in the first place. There is nothing sadder than people who do not invest in equities because of a lack of trust in markets and in brokers/dealers/advisers.

(2) The resulting choices will be as good as, or better, for me in my situation. My consumer surplus will increase, to use the technical term. In other words, I will get the money that the adviser does not get, plus the additional benefits that properly designed financial advice will bring, in terms of higher income in the longer run.

(3) There are knock-on effects. If financial markets are functioning well, it will be easier / less costly for firms to raise funds when they can make good use of these funds, and society as a whole will be better off.

On the down side, there may be additional compliance costs for the financial adviser. We have had this discussion on this forum before. But it still seems to me that these extra costs are small, when compared with the benefits listed above. (Of course, I have never tried to quantify them.)

I note in passing that the profession of which I am a member operates under a fiduciary standard for all clients. I can't imagine being able to function in any other way.

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Re: Does a fiduciary standard maximize social welfare?

Post by DanH »

kcowan wrote:I have come to think of financial advice to be like big pharma. We do not expect the pharma companies to act in the best interest of consumers. Why would we expect the FA community to be any different.
Ahem...present company excluded of course ;)

Very well said George - as usual. Compliance costs are very real. And the private client business - i.e. customized, individual advice - has some scalability but not a whole lot. Fund management (e.g. Mackenzie) and institutional money management (e.g. Jarislowsky Fraser) are highly scalable. But the investment counselling business today - which is how I'd describe our business - is a very high cost business. That's assuming you invest in professional grade technology systems - not using excel for everything - take compliance policies & procedures seriously; and take very seriously the obligation to clients (which really leads to the other items mentioned and more).

Now I'm not saying there isn't money to be made by the advice providers. But it can take a long time to get the point of enjoying the fruits of one's labour.

Back to the OP's question I'm not sure of how to measure social welfare. George has made some excellent points. But I still wonder if a best interest standard is going to make a big difference if a significant minority still misunderstand and fail to comply with the lower suitability standard. The current standard - if followed diligently - is a pretty high standard in my opinion and should function very much like a best interest standard. But maybe that's my bias showing.

Fiduciaries (i.e. firms registered as Portfolio Manager) are available today but their minimums are high ($500k and up). If everything is held to a best interest standard, the industry minimums are likely to rise and there will be fewer options for the majority of people with more modest portfolios. This is the so-called advice gap. Robo-advisors can play a role here but they are far from profitability. And as I pointed out elsewhere they are facing big challenges.
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Re: Does a fiduciary standard maximize social welfare?

Post by Shakespeare »

Regulators to desert 'best-interest' standard for advisers - The Globe and Mail
The Canadian Securities Administrators posted a bulletin on Thursday morning stating that all provincial regulators, excluding the Ontario Securities Commission and the Financial and Consumer Services Commission in New Brunswick (FCNB), will no longer be looking at implementing a mandatory best-interest standard that would have required a registered dealer or registered adviser to act in the client’s best interests – in a higher standard than the current model.
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Re: Does a fiduciary standard maximize social welfare?

Post by randomwalker »

DanH wrote: 16 Dec 2016 08:06
kcowan wrote:I have come to think of financial advice to be like big pharma. We do not expect the pharma companies to act in the best interest of consumers. Why would we expect the FA community to be any different.
Ahem...present company excluded of course ;)

Very well said George - as usual. Compliance costs are very real. And the private client business - i.e. customized, individual advice - has some scalability but not a whole lot. Fund management (e.g. Mackenzie) and institutional money management (e.g. Jarislowsky Fraser) are highly scalable. But the investment counselling business today - which is how I'd describe our business - is a very high cost business. That's assuming you invest in professional grade technology systems - not using excel for everything - take compliance policies & procedures seriously; and take very seriously the obligation to clients (which really leads to the other items mentioned and more).

Now I'm not saying there isn't money to be made by the advice providers. But it can take a long time to get the point of enjoying the fruits of one's labour.

Back to the OP's question I'm not sure of how to measure social welfare. George has made some excellent points. But I still wonder if a best interest standard is going to make a big difference if a significant minority still misunderstand and fail to comply with the lower suitability standard. The current standard - if followed diligently - is a pretty high standard in my opinion and should function very much like a best interest standard. But maybe that's my bias showing.

Fiduciaries (i.e. firms registered as Portfolio Manager) are available today but their minimums are high ($500k and up). If everything is held to a best interest standard, the industry minimums are likely to rise and there will be fewer options for the majority of people with more modest portfolios. This is the so-called advice gap. Robo-advisors can play a role here but they are far from profitability. And as I pointed out elsewhere they are facing big challenges.
I've been seeing as of late how well those who fall into the "advice gap" have been served by their so called "financial advisors" as they head into retirement with half to two thirds of what they otherwise would have had if they had simply invested their "modest portfolios" in a handful of low price index funds instead high priced actively manage mutual funds, worse still ones sold with "loads" or even worse "segregated funds."

This is an old discussion and as I've said before "we live in a world where you work for who pays you and that means for a financial advisor who is paid to sell mutual funds then the mutual fund company is the advisor's client."
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Re: Does a fiduciary standard maximize social welfare?

Post by randomwalker »

Shakespeare wrote: 12 May 2017 08:58 Regulators to desert 'best-interest' standard for advisers - The Globe and Mail
The Canadian Securities Administrators posted a bulletin on Thursday morning stating that all provincial regulators, excluding the Ontario Securities Commission and the Financial and Consumer Services Commission in New Brunswick (FCNB), will no longer be looking at implementing a mandatory best-interest standard that would have required a registered dealer or registered adviser to act in the client’s best interests – in a higher standard than the current model.
Thank for that. I was wondering what was driving the price of the publicly trade mutual fund companies.
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Re: Does a fiduciary standard maximize social welfare?

Post by randomwalker »

While we're at, in the category of "you say potato i say potahto" and i must admit to not knowing this until recently, perhaps because I deal with neither,

Do you have a financial advisor or adviser?
Moneysense, December 9th, 2016
by Stan Buell, Small Investor Protection Association

Most Canadians—including many financial journalists—believe that advisor and adviser are just spelling variations of the same word. But there are different meanings wrapped up in how those spellings are commonly used. And too often the word itself doesn’t mean much at all no matter which way you spell it.

Various government securities acts spell out the responsibilities of “advisers” to their clients. Meanwhile, the investment industry commonly calls their salespersons “financial advisors”...

http://www.moneysense.ca/save/investing ... r-adviser/
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AltaRed
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Re: Does a fiduciary standard maximize social welfare?

Post by AltaRed »

CBC amongst others also had reported in recent weeks on advisor vs adviser. I am told even that varies by province. Good luck in the shark pool.
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