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Commission bans - do private investors benefit?

by Charline Uhr, Steffen Meyer, Andreas Hackethal & Benjamin Loos
Posted on May 11, 2020

When using investment accounts based on commission schemes, the incentives of financial institutions and private investors might not necessarily be aligned. To curb the risk of a potential mis-selling and to protect private investors, regulators have reacted either by improving the information flow between the product provider and private investor, or – like in the UK and in the Netherlands – by banning sales commissions altogether.

The effect on the demand side – the private investors – has not been fully researched. Do private investors change their behaviour in response to commission bans? Do they benefit from flat-fee schemes for financial products by improving their portfolio efficiency? These are the main research questions investigated in our TFI project entitled: “How do flat fees for mutual funds affect private investor behaviour?” In this blog post, we are happy to share some of our preliminary results, which could be useful to banks and regulators when evaluating the consequences of abolishing commissions to private investors.

Field experiment in Germany

In August 2009, a large online bank operating in the German market was one of the first to introduce a flat-rate model for trading and holding mutual funds. This flat-rate runs in parallel with the bank’s traditional commission scheme. We analyse anonymized data from this bank between January 2008 and December 2015 to answer our research questions. Figure 1 shows the timeline of relevant events we study.

Figure 1. This figure shows the sequences of relevant events in the field study. The data we use for this project start in January, 2008 and end in December, 2015. For this period, we analyse anonymised trading records, portfolio holdings, recommendations by advisors and clients’ socio-demographic information.Figure 1. This figure shows the sequences of relevant events in the field study. The data we use for this project start in January, 2008 and end in December, 2015. For this period, we analyse anonymised trading records, portfolio holdings, recommendations by advisors and clients’ socio-demographic information.

Importantly, the scope and quality of all services offered to clients are identical in both schemes. When choosing the flat-rate, clients pay 1% p.a. of their total portfolio holdings (including stocks, bonds and funds). In exchange, clients can trade all mutual funds without paying any commissions. Under the traditional commission scheme, clients pay front-loads to the bank when purchasing mutual funds (on average, 2.0%) and annual management fees.

All clients, irrespective of whether they opt for the flat-rate or the commission scheme, may consult with a team of professional financial advisors at no extra cost over the phone. The advisors are randomly assigned to clients on a call-by-call basis regardless of the client or pricing scheme. The bank’s data we analyse contain anonymised trading records of 55,551 randomly selected clients as well as the date and recommendations of all advisor contacts from 2008 to 2015.

Flat-rate users benefit

We find that clients with a higher portfolio value, larger fund shares and better portfolio efficiency (diversification and performance) are more likely to opt in for the flat-rate scheme service. Clients choosing the flat-rate seem to be more financially sophisticated than their peers, who continue to take advice under the commission scheme.

We also investigate how clients change their investment behaviour (relative to a control group) after switching from the commission to the flat-rate service. Figure 2 shows the date when a client switches in the flat-rate (event-time 0) and the months before and after the switch. Our analysis shows an immediate reaction by those who switch. Users of the flat-rate (dotted line) talk more to their advisor, and increase their share of mutual funds, which increases their portfolio diversification. Users of the flat-rate also invest more in the stock market as they increase their portfolio values. On the bottom line, clients benefit by using the flat-rate by increasing their performance and reducing their portfolio volatility.

Figure 2: This figure shows the effect of the switch from the commission to the flat-rate scheme on measures of advice usage, portfolio allocation and portfolio performance for switching clients compared with propensity-score-matched commission scheme clients in event time, analysing the 12 months before and after the switch. Switchers are defined as commission scheme clients who switch to the flat-rate scheme. The dotted line illustrates clients switching into the new flat rate, whereas the solid line shows the propensity-score-matched control group of non-switchers.Figure 2: This figure shows the effect of the switch from the commission to the flat-rate scheme on measures of advice usage, portfolio allocation and portfolio performance for switching clients compared with propensity-score-matched commission scheme clients in event time, analysing the 12 months before and after the switch. Switchers are defined as commission scheme clients who switch to the flat-rate scheme. The dotted line illustrates clients switching into the new flat rate, whereas the solid line shows the propensity-score-matched control group of non-switchers.

Boosting trust in financial advice

Our results suggest that under the flat-rate scheme, clients are more likely to rely on financial advisors’ recommendations, especially those tips about more complex and international products. But why? As financial advisors do not earn a commission with each product sold, clients reported in a survey that they perceive the advice under the flat-rate of higher quality than that under the commission scheme. These are the results of a survey with a subsample of over 700 clients. Clients seem to trust their financial advisor a whole lot more under the new flat-rate service. These customers associate the flat-rate at the bank with fairer and better advisor recommendations and feel more confident in investing in international capital markets.

All in all, clients show to benefit more from using flat-rate services than commission based investment services. In the case we analyse, the financial advice and services don’t change - but only changing the pricing scheme of trading causes a substantial and beneficial change in investors’ behaviour. Motivating people to use flat-rate services, or offering other no-commission alternatives – our study suggests that this could improve the financial well-being of private investors when it comes to financial advice.

Charline Uhr is Research Assistant at Goethe University in Frankfurt and visiting PhD student at University of Southern Denmark

Steffen Meyer is Assistant Professor of Finance at University of Southern Denmark & Danish Finance Institute

Andreas Hackethal is Professor of Finance at Goethe University in Frankfurt

Benjamin Loos is Associate Professor of Finance at University of Technology Sydney