Significant product changes offer opportunities to engage clients, get to know them better and address suitability
By Michelle Schriver
If a tree falls in the forest and no one hears, does it make a sound?
No one is likely applying that question to the monitoring of product changes — part of firms’ obligation under the client-focused reforms (CFRs). With the potential for so many product changes to make so much noise, the real question is how to lower the volume.
The CFRs, in effect since the beginning of the year, include know-your-product (KYP) reforms that require dealers to formally assess and approve products, and monitor those products for significant changes. The changes then need to be communicated to advisors so they can reassess client portfolios for suitability.
“Significant” isn’t defined in the reforms, but changes across such data points as fund category, risk, cost and prospectus time horizon are generally agreed to be potentially significant, said Dave Carr-Pries, vice-president of consulting services with regtech firm InvestorCOM in Toronto.
The firm analyzed changes in the Canadian fund universe across those data points during the 12-month period ended May 31. Potentially significant changes resulted in plenty of data to parse:
- fund category changes (e.g., changes in investment style, geographic focus or sector concentration) occurred more than 2,000 times,
- 661 funds got riskier, and
- about 128 management expense ratios (MERs) gained at least 10 basis points. (MER changes of any magnitude accounted for 87%, or about 39,000, of all changes.)
Scott Sullivan, principal, Canadian products, with Edward Jones in Toronto, maintains a relatively conservative product shelf. The firm assesses product data using its own analytical tools, and many changes don’t affect suitability, even if they make a product more or less attractive, he said.
“With KYP, we’re monitoring for significant change to a product that might make it unsuitable based on what we know of the client through KYC [know-your-client],” Sullivan said. “A lot fewer [changes] happen in that regard.” In addition to category and risk-rating changes, he cited fund mergers as a potentially significant change.
Closer to the other end of the spectrum, Richard Rizi, vice-president of investment services with Worldsource Wealth Management Inc. in Markham, Ont., said the firm — which uses InvestorCOM tools — has seen “a lot” of fund changes this year. And a change to the fund manager, for example, may require more due diligence by the firm than a change to the risk rating, he added.
To parse all the data, “you really have to understand where the data comes from [i.e., data providers such as Fundata and Lipper], and who’s giving you the data,” Rizi said. “Most importantly, you have to determine what’s important for you as a firm.” Decisions about frequency also come into play. Worldsource looks at product changes monthly.
Monitoring is an evolving process, Rizi said, as is product comparison. In June, the firm added Sharpe ratio as a data point for comparisons.
The monitoring evolution has already led to some data improvements. Prospectus time horizon is a relatively less standardized and distributed data point, Carr-Pries said, and the CFRs motivated some dealers to specifically request the information. As a result, about 84% of time-horizon updates from data providers during the 12-month period analyzed by InvestorCOM were provided for the first time, and not because the funds were new, Carr-Pries said.
Parham Nasseri, vice-president of product and regulatory strategy with InvestorCOM, said that outcome was a positive unintended consequence of the reforms.
He also noted that, despite the common refrain that the reforms mostly codify what advisors already do, “all the [CFR] pieces have implications on the client-advisor dynamic.”
Specifically with monitoring, when a fund’s cost changes significantly, “what is the level of expectation around communicating that change to the end client?” Nasseri asked. Significant product changes offer opportunities to engage clients, get to know them better and address suitability in the client’s best interest, he said.
Carr-Pries suggested that, given notification that a fund’s category has shifted significantly, for example, advisors may have to consider whether an annual portfolio review is sufficient. “What’s the right time before an advisor addresses that portfolio and communicates with the client?” he asked.
More information for advisors is a positive, said Daniel Kratochvil, chief compliance officer with Mississauga, Ont.–based Agora Dealer Services Corp.: “You’re now giving more accountability to advisors to engage their clients.”
The challenge lies with compliance, Kratochvil said. The mutual fund dealers he has spoken with use tech to create alerts for changes, but must still interpret the data and filter it.
Nasseri noted that the reforms, including requirements for product comparisons and documentation, can advisors serve clients well amid volatile markets, when clients may complain about losses. “You can be ready and say [to the client], ‘Look, I have acted in your best interest,’” he said.
With the reforms, “what we have noticed overall,” Sullivan said, “is a higher standard on notes and what you’re documenting about your client.” Edward Jones provides auto-populated templates to streamline the process, he added.
And some of the most significant changes may be the ones happening within advisors’ books.
“We give [advisors] diagnostics on how many holdings they have” and where they rank among their peers in number of holdings, Sullivan said. Veteran financial advisors, in particular, tend to have less capacity and be following too many products. As a result of the diagnostics, those advisors have decreased their holdings by 5% to 10%, he said.
The reduction lets advisors spend more time on what’s important to clients: discussing life changes and how clients’ plans can adjust to meet their goals, Sullivan said.
With advisors expressing some strain this year with CFR obligations, finding ways to reduce the noise will continue to be important.
Source: Investment Executive