Research has shown that mutual fund disclosures are unnecessarily complex | Jobs Vox


Research has shown that mutual funds comprise 58% of retirement savings and are a popular and effective way to diversify risk.

“Mutual funds expose investors to a basket of stocks that offer different ‘flavors,'” he said.MIT Sloan Assistant Professor of Mathematics. That means they’re more efficient than picking a single stock and “being exposed to all the ups and downs of that stock,” she said.

Despite their popularity, some studies show that mutual funds underperform benchmark portfolios, and retail investors often make poor choices when choosing funds, choosing high-fee funds even when similar low-fee funds are available, Xie and her fellow co-authors note in their new study: Hiding in a mutual fund.

Part of the problem is that mutual fund investors have complex disclosures that make it difficult for them to make informed decisions, the study determined. The Securities and Exchange Commission recognizes this and has already expressed concern that mutual fund disclosures should have less ambiguous and more accessible language as more retail investors make their own investment decisions.

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“In the case of mutual funds, when retail investors shop for the right funds, they rely on the information that funds provide: basic information, such as their expected returns and expected expenses,” Xie said. .

Xie and her colleagues wondered: Could a strong text on disclosures be responsible for investors’ poor decision-making? Additionally, do complex fee structures make it difficult for investors to compare funds and distinguish between management and maintenance fees and other costs they may incur in choosing a particular fund?

To find out, the authors collected a sample of 38 mutual funds from the S&P 500 index between 1994 and 2017. All funds are allocated to self-directed retail investors. They chose the S&P 500 because these index funds have “largely similar” total investment returns and risks, but charge different fees and have different net returns.

The authors examine narrative complexity in currency futures and summary forecasts, a common source of information for retail investors. To measure narrative complexity, they observed the following.

  • How many specific funds are included in a prospectus?
  • The summary phase of the prospectus duplicates language from the details section, thereby adding to confusion.
  • How many words were in an average sentence?
  • How long the entire prospectus and summary cost statement have been.

It also measured structural complexity based on the fund’s share classes and types and payout levels.

The results showed “strong and positive associations” between payments and narrative and structural complexity. Funds with higher narrative complexity (unreadable disclosures) and structural complexity (more complicated fee structures) were also higher-fee funds, suggesting that this complexity is perhaps designed to “hide” higher fees.

The authors were particularly surprised by the findings because mutual fund disclosures are highly regulated and because the conventional wisdom is that index funds are an inexpensive way to get a diversified portfolio.

The authors suggest that supervisors can take the following three steps to investigate fraud.

Language is simple As the SEC continues to develop and enforce rules to improve fund disclosures, regulators should encourage simplification and revisit their 2009 ruling on multi-fund estimates or summaries of more than a certain length.

Strict control over payment structures; The authors pointed out that Structurally complex funds are more expensive than simple funds. “Although the SEC has raised concerns about these fees and accused advisors of lack of transparency, it has not yet banned them,” they wrote.

Increasing the responsibility of consultants; The SEC requires advisers to recommend financial products that are in a client’s best interest but limit their liability when making recommendations on mutual funds from different companies. However, as the researchers found significant variation among S&P 500 funds, “the SEC should probably increase the responsibilities of advisers, at least for very similar index funds.” [with different fee structures]He said.

It’s important to note that their findings “do not make strong claims that this was intentional,” Xie said.

“Strategic features could have been inadvertently enhanced,” she warns, perhaps because mutual funds are mimicking the sophistication and fees of other financial intermediaries.

That said, there is still evidence that “fund managers resist the SEC’s efforts to reduce complexity in fund disclosures.”

For example, the authors looked at the impact of two 2009 SEC regulations designed to reduce narrative complexity. Funds with the most narratively complex disclosures before 2009 found that their narrative complexity decreased more than other funds after the rules became effective, suggesting that prospectus narrative complexity is at least partially rational, the authors concluded.

Overall, “our results suggest that unreadable disclosures are part of a strategy intended to extract rents from retail investors,” the authors wrote.

Read next: Retail investors lose big on options markets, says study


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