Selective disclosure

Although the evidence is far from conclusive or unanimous, there are many experts who believe markets are highly efficient and certainly efficient enough that it does not make sense to try to exploit whatever mispricings might still exist. For them, fundamental and technical analysis, market timing and similar methods seem nearly useless. Although it is certainly possible to be successful using those techniques, it is far from probable.

Curiously, relatively few advisors mention this to their clients.

How, exactly, can you expect someone to choose an option if the person isn’t aware an option exists? As far as I can see, the financial services industry has been doing exactly that pretty much from Day One. By cherry picking what most advisors are taught and by extension, the resulting recommendations that are ultimately made to investor clients, the industry has been less than complete in its preparation of new advisors.

Indeed, the Canadian Securities Course (CSC) devotes only one paragraph to the Efficient Market Hypothesis. The other many hundreds of pages imply (not necessarily demonstrate) that those techniques remain useful. In contrast, most MBA finance courses devote about 20% of their content to dealing with the subject of market efficiency.

The difference, it would seem to me, is that University courses have a mandate to offer a balanced position on subject matter that is in factual dispute. The CSC, in contrast, has no such mandate. The course is designed by the industry with a mandate to prepare people in respect of rules and regulations of the industry, customary and required practices of good business conduct, industry background, general investment knowledge, factors affecting investment (i.e. taxation) and matters deemed to be in the public interest. Given that broad mandate, the CSC is at best only a macro view of investment management.

Why not show some natural curiosity to see what you’re missing? Perhaps Internet searches on the likes of Eugene Fama, the Efficient Market Hypothesis and William F. Sharpe would be helpful.

Although I personally favour the paradigm of market efficiency, I also allow my clients to invest 100% using active management, if that is their wish. I have strong views but respect those people who have equally strong views that are not in accordance with my own. Denying my clients of their ‘right to be wrong’ is not a practice that I can condone- after all; it’s their money.

This brings me to a recent situation that I found myself in. I was preparing to give a presentation to a large number of consumers and submitted my slideshow for compliance approval. Part of my talk was to compare and contrast active management and passive management, including the importance of disclosure.

In the end, I was required to insert a disclaimer that read (in part): “Debate regarding market efficiency, the usefulness of fundamental and technical analysis, active versus passive management and the efficiency of fee payments is ongoing. To date, neither side of these debates has been able to claim unchallenged victory.”

I’m fine with that passage. In fact, I rather like it so much I wish everyone else in the business would use it, too. My concern is that pretty much every presentation ever given in the history of the Canadian financial services industry has been given without that kind of disclaimer. That silence is the antithesis of meaningful disclosure. It’s willfully not talking about certain things because bringing those things to someone’s attention might cause them to actually think critically and question their pre-existing beliefs. As I see it, by remaining silent on the matter, member firms and their advisors can subtly imply that the issue either isn’t an issue at all or at the very least that it isn’t very important- simply because it is not mentioned.

I have never seen or heard of a compliance department that insisted their an advisors, in publicly espousing the virtues of security selection and/or market timing, include a reference in the material’s disclaimer that evidence in favour of active management is not definitive. Advisors favouring active management are simply silent on the matter and no compliance department that I am aware of (other than my own) has ever required that such an advisor either disclaim his views as being uncertain at all. Virtually everyone in the business acts as though active management is unequivocally sensible management by only showing active alternatives to their clients.

In my mind, this practice is both presumptive and hypocritical. It presumes that there is no need to disclaim the fact that active alternatives might not always be best. It is hypocritical because the industry has been built on the principle of the client coming first through the use of full, true and plain disclosure. My experience is that most proponents of active management don’t disparage the alternatives; they simply act as if they don’t exist.

John De Goey, CFP, is the vice president of Burgeonvest Bick Securities Limited (BBSL) and author of The Professional Financial Advisor II. The views expressed are not necessarily shared by BBSL. You can learn more about John at his Web site: www.johndegoey.com.