Dear Santa, Or Morningstar’s Financial Wishlist for 2024

Dear Santa,

It’s been a rough year for Canadians, with inflation eating away at our hard-earned dollars, mortgage interest payments doubling for people who come up for renewal this year, and of course the ongoing emotional strife around loved ones in the Ukraine and now in Israel-Palestine. All of this, Santa, has made for quite a tiring 2023. 

But things aren’t all bad for investors – this year the CFA Institute in conjunction with the United Nations Principles of Responsible Investing, and the Global Sustainable Investment Alliance, released a global terminology paper, adding much-needed clarity to the way investors talk about the various approaches to sustainable or environmental, social, and governance (ESG) related investing. Although investors have pulled back on sustainable investing this year (with our data showing net outflows across the globe, including here in Canada), we hope that this paper, and the adoption of standardized terms, makes it easier for Canadians to invest sustainably and reduce greenwashing.

3 Things We Wish for in 2024

As we look ahead into 2024, here are three things that we wish for investors this holiday season:

1. More Choice at the Bank Branch. In Canada, most financial institutions offer a limited set of investment products small and newer investors who seek to buy mutual funds from retail bank branches. These investment funds (aptly named “proprietary products”) are often manufactured by the investment management arm of the same bank, allowing said banks to take advantage of the wide economic moats that they’ve built via their massive networks and brick and mortar presence. This said, regulation changes known as the Client Focused Reforms, and recommendations from Ontario’s Taskforce for Modernization of Capital Markets were supposed to curb the oligopoly, discouraging banks from solely selling their own products to make room for independent fund manufacturers on product shelves. To be clear, bank-managed mutual funds aren’t necessarily a bad thing – many of them perform reasonably, and have served investors well over time. However, as a principle, we believe that investors should be provided with a variety of choice when dealing with our well-known financial institutions (often a first stop for new investors and those new to Canada). This fosters competition in the industry and should drive fees lower to the benefit of Canadians.
   
   
2. That Investors Stick it Out. Every year Morningstar conducts a study called “mind the gap” which measures the difference between fund returns, and investor returns (derived by Morningstar’s asset flows data). Most of the time, the study finds that investors generally get lower returns than that of the fund for one reason: timing. As emotional beings, investors tend to either buy too late (following trends), or sell to early out of panic. Because of this, their returns never match up to the long-dated returns that are advertised by investment funds. This is especially prevalent when looking at thematic funds (or those that invest in a broad trend like “big data” or “automation”). These imagination-capturing investment products have sold well in Canada, however their risk-adjusted returns leave much to be desired, and should be far from core staple in the average Canadian’s portfolio. The ‘return gap’ is especially prevalent in these types of thematic investments given their general volatility and usually narrow sector exposure.  We often say that investing is simple but not easy. Investing involves a tradeoff between risk and reward, which at the best of times is a very unintuitive choice for people to make.  
   
   
3. That Canadian Advisors Live Up to their Names. The recent regulatory reforms that had every intention to make the world better for Canadian investors has put immense burden on advisors and the firms that they work for. To adapt to these needs, advisors must rely more on technology. However, not all technology provides analysis deep enough for an advisor to truly understand an investment product. We wish for advisors to stop and think about the quality of analysis that their systems are providing when giving advice to Canadian investors. The idea of “knowing a product” before recommending it should involve much more than a couple of mouse-clicks. As large language models like ChatGPT continue to evolve, the temptation of an advisor to lean on technological shortcuts will likely continue (remember when you could recall phone numbers by heart?) Real analysis takes time and critical thinking to ensure that whatever product is being recommended is appropriate for a client’s risk tolerance and risk capacity. We wish that advisors take the time to ensure that this is done properly, with the right detail of analysis that goes beyond a comparison of returns and fees.  This is part of the value of advice, which is worthwhile if done properly.
   
   

Also, would love a new set of tires, mine are over-inflated.

Sincerely,
Ian Tam, CFA

Ian Tam, CFA is Director of Investment Research for Morningstar Canada, a wholly owned subsidiary of Chicago-based Morningstar Inc. Ian is also a voting member of the Canadian Investment Funds Standards Committee, a member of the CFA Institute’s Global ESG Technical Committee, and recently appointed as a member of the Ontario Securities Commission’s Investor Advisory Panel.