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Trailing fees: What your mutual fund advisor now has to tell you

Canadians love mutual funds, and our financial advisors love to recommend them to us.

We keep roughly $93,000 per capita in invested funds; nearly double the estimated $48,000 US per person south of the border. That’s one-third of the $3.4 trillion of wealth we have invested as of 2013. Fifty-nine percent of that wealth was invested with the help of a financial advisor according to data from CIBC World Markets.

However, research from the Canadian Securities Administrators (CSA) suggests a large number of Canadians are unaware or have a limited understanding of how financial advisors are compensated.

The answer in large part is trailing commissions, an ongoing fee of one percent on your average equity fund and half a percent on a typical bond fund, paid to the advisor for having recommended and secured the purchase of the fund unit for the client.

“Industry data suggest that the average trailer fee across all asset under management (AUM) types in the industry is roughly 60 basis points. Therefore, total mutual fund AUM today of approximately $1 trillion implies fund companies are paying and advisory firms are collecting roughly $6 billion annually in trailer fees,” said CIBC World Markets analyst Robert Sedran in a research note.

“It really just amounts to a fee in effect to try and ensure that the client continues to hold the fund so that the fund company can continue to carve off an operating expense from that holding. In that sense we are quite concerned that it leads to biased advice. There can be no doubt that it has an impact,” said Neil Gross, executive director of the Canadian Foundation for Advancement of Investor Rights (FAIR).

He worries about advisors kowtowing to fund companies now that trailing commissions have become their primary revenue stream. In 1996, Canadian advisors’ compensation mix was 73 percent sales commissions and 27 percent trailing commissions. By 2011, those figures had shifted to 36 percent sales commissions and 64 percent trailing commissions, according to the CSA.

Groups like FAIR and the Ontario Securities Commission’s Investor Advisory Panel have been long called for an outright ban on trailing commissions. Gross hopes the new disclosure guidelines required by the Client Relationship Model 2 (CRM2)’s three-year implementation will give investors a clear idea of what advisors stand to gain on each acquisition, and let them weigh cost of advice against potential returns, and other competing products on the market.

Basically, advisors will need to spell out in everyday English if they will personally gain if you pick fund X over fund Y.

“The question is whether CRM2 is going to result in the type of disclosure that is understandable and useful for investors. We have some concerns about that now. Early indications are that some players in the industry may try to provide the information in a way that is not understandable and not useful to investors,” said Gross.

Concerns with the status quo came to the CSA in December 2012 through responses to a discussion paper released by the regulator. Many worried trailing fee revenue was causing investment advisors to flog products rather than dole out advice.

Defenders of the current trailing commission model also voiced concerns to the CSA. They say there’s no evidence of investor harm that warrant changes to the fee structure, a claim the CSA is currently investigating. They also say reforms would ultimately make advice less accessible and create an uneven playing field since not all products are being scrutinized.

CANADIANS GET AN “F” IN PERSONAL FINANCE

A lack of financial literacy is at the core of the problem says Rob Carrick, a personal finance columnist at The Globe and Mail.

“There are fund fact documents that are passed out when you buy funds and they have the information there. You can always just Google up the name of your fund and fund facts, and it will be there in plain English. These are very very easy to understand documents,” said Carrick in an interview with BNN.

FOREIGN FEES

While CRM2’s strengthened disclosure requirements bring Canada more in line with the norm in other advanced economies; Canadian fees remain pricey compared to peers.

“Canadians in particular find themselves paying among the highest, if not the highest mutual fund fees in the world. There is no convincing structural explanation for that. We are largely being taken advantage of. The U.K. is light years ahead of Canada,” said Gross.

He points to the Netherlands where trailer fees were voluntarily abolished with the blessing of the advisor industry there.

SO HOW WILL ADVISORS MAKE MONEY?

The simplest solution would seem be for advisors to charge clients a separate fee along with the products they purchase.

“Haven’t we gotten past this yet? We need to professionalize advice people and [have them] say, ‘We provided advice. It’s useful stuff. Here’s how much we charge.’ Just like accountants do. Just like lawyers do. The cost of products is totally separate. We really need to move in that direction, I think,” said Carrick.

“Really it will only be the advisers who have not been providing that level of service and have no value to give who won’t be able to recapture the same amount of money. Those people, if they are not prepared to step up what they provide, will be in a bad position.

“There will be some weeding out, and that’s not going to be a bad thing if it gets rid of bad advisors. Nobody should cry about that,” said Gross.

​-With files from Martha Porado
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