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