Open Letter to Ken Woodard (MFDA) and Sandra Kegie (Federation of Mutual Fund Dealers)
Sandra:
Since PureLogix Corp. specializes in this area, I thought I would pass on our thoughts to you.
Concerning using a calculator to calculate risk tolerance:
We agree, trying to mix investment objectives, time horizon and so on into a single score makes little sense. Prospects in the past have suggested similar 'all-in-one' calculations to us. We have always said 'no' for similar reasons to the MFDA; a computer should never replace human judgment, it should only replace repetitive number crunching.
For example, in our compliance software platform called Compliance Net, the computer calculates the risk of each fund (as well as the entire account) and compares results daily to the last updated KYC data for each client account. This is a simple, repetitive process that really cannot be completed better by a human being using a trade blotter. However, when reviewing possible churning issues, or reviewing investment objectives or client age (and so on), Compliance Net looks for unusual matches and asks the advisor to comment on the discrepancy. The notes entered by the advisor are then routed to a compliance officer to review and approve or request more information from the advisor if necessary.
We've gone this route because human judgment must be a part of the suitability process. For example, an 80 year old client should be allowed to invest in 100% high risk funds (assuming the risks have been explained properly to the client). We feel a computer assisted compliance program like Compliance Net should automatically flag the account and ask the advisor to detail the discussion and disclosure process that has been used with the client and a compliance officer should use their own judgment to decide if the disclosure is sufficient. A computer can never completely replace this 'second look' at an account, but a computer can and should make sure every account is addressed and every account has notes electronically documented (a problem human-only procedures often fall short on).
Concerning disclosing risk tolerance of individual funds or an entire account:
Here we only partially agree with the MFDA. First, with Compliance Net we opted to disclose the risk of each individual fund AND the entire account to the investor. Although we understand the MFDA's desire to disclose the risk of all individual funds to a client, we think it isn't a consistent rule, nor does it adequately disclose risk to an investor. Here's why:
Since PureLogix Corp. specializes in this area, I thought I would pass on our thoughts to you.
Concerning using a calculator to calculate risk tolerance:
We agree, trying to mix investment objectives, time horizon and so on into a single score makes little sense. Prospects in the past have suggested similar 'all-in-one' calculations to us. We have always said 'no' for similar reasons to the MFDA; a computer should never replace human judgment, it should only replace repetitive number crunching.
For example, in our compliance software platform called Compliance Net, the computer calculates the risk of each fund (as well as the entire account) and compares results daily to the last updated KYC data for each client account. This is a simple, repetitive process that really cannot be completed better by a human being using a trade blotter. However, when reviewing possible churning issues, or reviewing investment objectives or client age (and so on), Compliance Net looks for unusual matches and asks the advisor to comment on the discrepancy. The notes entered by the advisor are then routed to a compliance officer to review and approve or request more information from the advisor if necessary.
We've gone this route because human judgment must be a part of the suitability process. For example, an 80 year old client should be allowed to invest in 100% high risk funds (assuming the risks have been explained properly to the client). We feel a computer assisted compliance program like Compliance Net should automatically flag the account and ask the advisor to detail the discussion and disclosure process that has been used with the client and a compliance officer should use their own judgment to decide if the disclosure is sufficient. A computer can never completely replace this 'second look' at an account, but a computer can and should make sure every account is addressed and every account has notes electronically documented (a problem human-only procedures often fall short on).
Concerning disclosing risk tolerance of individual funds or an entire account:
Here we only partially agree with the MFDA. First, with Compliance Net we opted to disclose the risk of each individual fund AND the entire account to the investor. Although we understand the MFDA's desire to disclose the risk of all individual funds to a client, we think it isn't a consistent rule, nor does it adequately disclose risk to an investor. Here's why:
- Fund of funds and various wrap products are often made up of medium risk, high risk and low risk funds. Fund managers only disclose the overall risk of the umbrella fund. If that is considered good enough disclosure for a fund of fund, it doesn't make much sense it isn't enough disclosure for a portfolio of mutual funds put together by an advisor. Our guess is the MFDA is avoiding disclosing portfolio risk to the investor because the MFDA has no way to calculate this number themselves. (We have offered the MFDA access to Compliance Net and our other tools to help with this process, but we have not received any comment back to date).
- If you say to an investor, 'your account is 90% medium risk and 10% high risk' the client is more confused than ever. Describing 'high risk' or 'medium risk' is difficult enough without throwing fractions into the discussion. PureLogix risk assessment tools display the historical risk AND return of all funds within a portfolio. On the same graph we display the historical risk and return of the entire portfolio.
Again, PureLogix agrees with disclosing the risk of all individual funds within a client portfolio, but also strongly advocates disclosing the risk of the entire portfolio. To not do so when tools are readily available is effectively ignoring fiduciary duty to Canadian investors.
Sincerely,
Edward Iftody, PureLogix Corp.
Labels: compliance, mutual fund, trade suitability
posted by Edward Iftody, BA, CIM at
5:14 PM
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