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Differences in cross-share market timing performance and advisors’ compensation also
suggest that the study results are evidence of conflicted advice, rather than the inexperience of
investors transacting through intermediaries. Bullard, Friesen, and Sapp showed that investors in
Class B shares, for which advisors can receive higher compensation upon sale compared to other
share classes, exhibited a performance gap of 2.28 percent, which was 41 percent and 71 percent
greater than the performance gaps of Class A and Class C shareholders, respectively; the
differences in timing performance between share classes B and A and share classes B and C were
statistically significant. One reason why Class B shares may provide higher compensation is that
their sales loads do not decline with investment size.
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The recommendation of Class B shares
over other share classes could be an indicator of the extent to which advice is conflicted. More
conflicted advisors may recommend Class B shares and may be more likely to chase returns,
inflicting greater damage to client portfolios through poor market timing.
Poor Advice Due to Misguided Beliefs
A different, and relatively new, strain of economics research has suggested another
reason for poor investment advice: the misguided beliefs of financial advisors. Explanations of
poor advice predicated on misguided beliefs are not necessarily mutually exclusive from
explanations based on conflicts of interest. In a study of advisers from three Canadian firms,
Juhani Linnainmaa, Brian Melzer, and Alessandro Previtero found some evidence suggesting
that advisors make poor recommendations in response to conflicts of interest and stronger
evidence that advisors give poor investment advice due to misguided beliefs.
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Specifically, Linnainmaa et al. found that trades that were both costly and without
apparent benefits to the client were significantly more frequent when the advisor gained
financially from the trade, providing evidence of conflicted advice. Such trades – which the
authors called “self-serving trades” – amounted to 5.4 percent of total trades. By contrast, trades
that were both costly and without apparent benefits to the client, but did not increase the
advisor’s compensation, only occurred 2.9 percent of the time. The difference between these two
types of trades was both statistically and economically significant. (Table 4 presents the data
from the study.) In the study, a trade was defined to benefit the advisor if, ceteris paribus, the
advisor 1) earned a new sales commission from the fund company; 2) charged the client a front-
end load; or 3) increased the trailing commission.
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A trade was defined to cost the client
financially if, ceteris paribus, the client 1) paid a front-end load to the advisor; 2) experienced an
increased management expense ratio as a result of the trade; or 3) had to pay a deferred sales
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Ibid. As Bullard, Friesen, and Sapp write, “One reason that Class B shares can be more lucrative is that Class A
share sales loads typically decline with the size of the investment, whereas Class B share deferred sales loads do not.
When a client invests a large amount, his broker therefore can receive a much higher payment by purchasing Class
B shares instead of Class A shares. Some fund firms have addressed this concern by capping the size of Class B
share purchases. Even when the client does not sell the shares and pay the deferred sales load, the broker often
receives a commission because many funds’ principal underwriters pay the broker a flat commission at the time of
the Class B share sale, which the underwriter then finances from the 12b-1 fee income stream.”
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Juhani T. Linnainmaa, Brian T. Melzer, and Alessandro Previtero. Costly Financial Advice: Conflicts of Interest
or Misguided Beliefs? December 2015.
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Ibid. 12. “A trailing commission is a recurring payment from the mutual fund company to the advisor. The fund
pays the trailing commission for as long as the client remains invested in the fund. Trailing commissions of 0.25% to
1% per year are standard on all funds sold by advisors.”