by Karin Mizgala MBA, CFP
There is a very interesting dialogue going on in the investment industry around the issue of mutual fund commissions and whether Canadian investors are getting the short end of the stick. The Canadian Securities Administrators (CSA) published a discussion paper that is the best summary I’ve ever seen about the mutual fund industry and advisor compensation.
Reading through the paper I’m reminded of 2 things: 1) the inner workings of the fund industry is very complicated – no wonder most people don’t understand how it works and 2. the current system does not work in the best interests of investors. This doesn’t mean that mutual funds are bad or that financial advisors that sell funds are scoundrels. It simply means that there’s something wrong with how mutual fund fees are charged and re-distributed.
To summarize as simply as I can, when you buy a mutual fund there is a fee (MER) that is charged within the fund that covers the management, marketing , distribution and administration of the fund. You don’t necessarily see this fee but in 2011 the average MER in Canada was 1.93%*. If you buy mutual funds sold through banks or advisors, a portion of this fee is paid by the mutual fund company to your advisor for providing financial advice. According the CSA report, approximately 50% of the MER is paid out to advisors.
One of the problems with this structure is that every client who purchases a mutual fund from an advisor pays for advice that they may or may not be getting. And since most clients don’t actually know how much they are paying their advisor, it’s pretty hard for them to assess if they are getting value for their money.
Reforms in both the UK and Australia recently include a ban on commissions and they have moved to a system where advisors are required to negotiate fees for advice directly with their clients and the cost of this advice is no longer embedded in the cost of buying a mutual fund. Since the fee will be more visible to clients, advisors will need to clearly outline what services they are providing and clients will be in a better position to evaluate the value of those services.
CSA is currently reviewing feedback from the public and industry on this issue to determine if regulatory responses are needed. In my view unless Canada follows the UK and Australia’s lead on banning advisor commissions, it’s not going far enough for the average Canadian investor.
Do you think mutual fund commissions should be banned? We’d love to hear your opinion!
*Investor Economics Insights 2012 Annual Industry review
Karin Mizgala is Money Coaches Canada’s CEO and resident “money shrink”.
I’ve been disputing with my financial institution for years about this. I’ve since removed myself from them and am using a discount brokerage to lessen the MER. That has helped a little, but it still does not give the investor a fixed $ value that they are shovelling out to the management team of a given fund. I’ve never seen it clearly displayed anywhere. they will discretely withdraw from your investment, which fluctuates on a daily basis, so it’s near impossible to truly see what has been withdrawn. My opinion, CSA needs to protect Canadians so that we can have a strong future and economy for generations to come.
If you go to the dealership for car maintenance, they don’t hide the labour cost into your mortgage payment… Why should investment funds hide MER’s withdrawals in the pool of investments.
Negotiating a MER or comission upfront would be a fair game for the Canadian and investment fund management team.
Great Article.. Take a look at the Regulator, and what they are doing. They did publish a working paper for all Marketing directors to plan for this change.. It looks like legistlation is comming The mutual regualtor, did advise the implimentation will be 2 years away. If you hold a Mutual fund licence you most likely will have been notified of this change. Some of our clients who are Advisors paid on commission.. have said they will be changing to the exempt market, where the commissions are regulated at 10 % .. 10 % of funds placed are allowed as commissions.. So what and see.. how inventive this investors will be shifting client money to the exempt market. We saw an office of 15 mutual fund advisors, and all 15 are currently working on studing for the tests to get licenced under the “Exempt market ” Funds.
No, I don;t think mutual fund commissions should be baneed. I believe in consumer/investor choice.
Disclosurer: I am a CFP in the process of retiring. In my almost 20 yrs in the industry, I have found that most clients prefer fees that are embedded, to direct payment of fees. Even more important, some commissions/fees (e.g. DSC fees) discourage clients from emotional buying and emotional selling.
Disclosure: I’m a fee-for-service CFP professional.
Don: I imagine you are an experienced, ethical advisor that discloses all fees. Your clients know that you get a % of mutual fund sales upon point of sale as a commission and it repeats every year thereafter. Your clients also know that deferred sales charges (DSC) are additional fees. Is a DSC really a deterent to promote good investor behavior? Not really, as you can avoid DSC charges by moving funds within a fund family. I also believe in choice. Let the client choose whether they want fees embedded or paid separately.
Thank you Karin for voicing my frustration in this matter.
I used to have Sheila as my financial adviser and was saddened when she left Assante. I am now with Ken Labron. I am frustrated because the statements that I receive every six months just show the totals of my shirking portfolio and not where the money is going.
glad to be the initial comment. I have a number of thoughts as this is one of my chief concerns with the financial industry in Canada.
First – Commissions don’t need to be banned. They do at least need to be reformed. A ban would require extra “realized” out of pocket cost to the investor, and, should mutual funds not lower their MER’s, then the real cost of the investment would increase. This is not idea. If instead the commission was still paid by the mutual fund to the broker, yet, the transaction was itemized and by law, pointed out to the client, they would be free to assess the value of the broker’s fee. To add to that idea, a system that also allowed the broker to reduce that commission, and thus the overall cost to the investor, may serve to entice sales/gain new clients (such as the real estate agent who drops their commission from 5% to 4% to gain a client).
Second, and an issue not covered, but I feel is closely tied to the “value” a client feels they receive, is the way that MER’s are translated from % to $$$. I believe that the current system of basing an MER off of the total assets managed is completely destructive to the investor, let alone misleading. For example $1000 invested with a gain of 10% = $1100. A 2% MER at the end of the year = $22 (1100 x 0.02 = $22). Thus, the mutual fund is taking 22% of the profit. (22/(1000 x 0.01) = 22%). And that is the best case scenario. If the mutual fund loses 10% of your money, then you still have to add on the MER. In our previous scenario $1000 invested loses 10% leaving $900. $900 x 2% MER = $18. Your total lose is $118 (10% of $1000 plus MER calculated after loss) or, as a %, 11.8% (118/1000=11.8%). In my opinion, this simply adds insult to injury.
So I’d offer a second option. What if mutual funds only charged an MER when they were profitable? Thoughts?
The CSA discussion paper is a very accurate and comprehensive view of how mutual funds are distributed. Highly recommended reading.
As the debate goes on about commissions and advisor compensation, I’m struck by the doom and gloom being painted if commissions are banned. The current advice model is an avenue for the little guy to get advice from a paid professional. Otherwise, it’s not affordable??
A transparent fee for advice would be the outcome of a commission ban. The professional experience in this service is relatively immature. That does not mean it can’t quickly respond to demand when the “hidden sales fees” are eliminated. The market will adjust and the little guy would get more “good” advice then they are getting now.
I’m amazed, I have to admit. Seldom do I encounter a blog that’s both
educative and entertaining, and without a doubt, you’ve hit the nail on the head.
The issue is something too few men and women are speaking intelligently about.
I am very happy that I came across this.