Howard Jones is an Associate Professor of Finance at University of Oxford Saïd Business School. This post is based on a recent paper, forthcoming in The Review of Financial Studies, by Professor Jones; Gordon Cookson, Associate Director at KPMG UK; Tim Jenkinson, Professor of Finance at the University of Oxford Saïd Business School; and Jose Vicente Martinez, Assistant Professor of Finance at the University of Connecticut.
Retail investors in mutual funds are faced with a bewilderingly wide choice of products. Traditionally, they would be guided by their broker, but increasingly they are investing in mutual funds through online investment platforms, or ‘fund supermarkets’. These platforms produce recommendations of funds to help investors make their choice. Using a unique, largely non-public, dataset sourced from the United Kingdom financial regulator, the Financial Conduct Authority (FCA), we address three questions about these ‘best-buy’ lists— how they are drawn up, whether investors follow them, and whether they add value. We investigate whether platforms’ recommendations are tilted towards two categories of funds from which they are especially likely to benefit: funds affiliated with the platforms themselves and those which share a large part of their own commission revenues with the platforms.
Background and Data
In the United States, the distinction between brokers and investment platforms is not clear-cut, as many brokers also operate platforms and do not break out the flows through different channels—nor do they publish their fund recommendations in a systematic way. Prior research working with U.S. data has found that broker-mediated mutual funds have higher fees and worse performance (Bergstresser, Chalmers, and Tufano 2009; Chalmers and Reuter 2012; Del Guercio and Reuter 2014), and that the incentives of brokers intermediating mutual funds, notably revenue sharing, drive flows into those funds (Christoffersen, Evans, and Musto 2013). However, these studies have not been able to separate recommendations from other, unobservable benefits which brokers may provide to retail investors, such as advice on the appropriate mix of asset classes. The U.K. platforms we study are intermediaries which limit their advice to recommendations, which they make freely available across a wide range of asset classes and regions. Moreover, our regulator-sourced dataset includes non-public details of the fees charged by asset managers, the fraction of these fees shared with platforms and, for two of the platforms, the investor flows into mutual funds that were channeled through the platforms. We are therefore able to make a more direct link between recommendations on the one hand, and incentives, flows, and fund performance on the other than has been possible hitherto.
Comment on the Proposed DOL Rule
More from: Max Schanzenbach, Robert Sitkoff
Max M. Schanzenbach is the Seigle Family Professor of Law at the Northwestern University Pritzker School of Law and Robert H. Sitkoff is the John L. Gray Professor of Law at Harvard Law School. This post is based on their comment letter to the U.S. Department of Labor. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here) and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Robert H. Sitkoff and Max M. Schanzenbach (discussed on the Forum here).
We are writing in response to the above referenced proposed rulemaking by the Department of Labor (the “Department”) on financial factors in selecting plan investments (the “Proposal”), in particular environmental, social, and governance factors (“ESG”).
This response is based on our expertise in ESG investing, especially ESG investing by trustees and other fiduciaries. We have undertaken several years of scholarly study of ESG investing by fiduciaries, and recently published our conclusions in “Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee,” 72 Stanford Law Review 381 (2020) (“ESG Investing by a Trustee”) (discussed on the Forum here). In a consulting capacity for Federated Hermes, Inc., moreover, we have prepared several white papers and videos and conducted training sessions on ESG investing for trustees and other fiduciary investors.
Introduction
In general, we are supportive of the Proposal’s central purpose of subjecting ESG investing to the same fiduciary principles of loyalty and prudence that are applicable to any type or kind of investment. For the reasons elaborated in ESG Investing by a Trustee, doing so is consistent with the fiduciary principles codified by the Employee Retirement Income Security Act (“ERISA”), with the case law interpreting ERISA, and with the background common law of trusts.
READ MORE »