A substantial number of do-it-yourself investors are paying for financial advice they are not getting and never will.
That’s what can happen when you buy mutual funds from an online broker. While you typically pay nothing to buy and sell your funds, the cost of owning them can be identical to what is paid by investors who have advisers.
There’s almost a conspiracy of silence on this matter in the investment industry and it results from the fact that the status quo serves brokers and fund companies quite well.
Mutual funds and online brokers don’t seem like an obvious combination, yet funds account for 14 per cent of the $228-billion invested through online brokerage firms, the latest retail brokerage report from Investor Economics shows. Stocks, of course, are the top choice at 66 per cent. Cash and cash equivalents such as Treasury bills account for 12 per cent of assets and bonds and guaranteed investment certificates account for 8 per cent.
Wondering where exchange-traded funds fit in? ETFs are an excellent option for DIY investors because they’re so cheap to own and manage, but they account for just 4.3 per cent of online broker assets (Investor Economics lumps them in with stocks).
For the time being, mutual funds are a much bigger business for online brokers than ETFs. Funds are also more lucrative, which may explain why so few firms have done anything to cut the cost of investing in funds for clients.
Four years ago, RBC Direct Investing became one of only a tiny minority of online brokerages to offer cut-rate funds to its do-it-yourself clientele. The firm introduced a D-series of RBC-brand mutual funds with fees that were cut substantially. The response from other online brokers? Actually, there was none.
“I would have thought after we launched D-series that the rest of the industry would have followed, and we haven’t seen that,” said Jason Storsley, CEO at RBC Direct Investing. “We thought we were setting a new trend.”
Besides RBC Direct Investing, the brokers that offer any type of a discount for do-it-yourself investors who own funds are Qtrade Investor and Questrade. Qtrade’s initiative is new and small in scope, but it bears watching because it makes a very small number of F-class mutual funds available to clients.
Many popular mutual funds have a low-cost F-class version that is designed to be used by fee-based investment advisers. F-class funds strip out trailing commissions, a component of fund fees that mutual fund companies channel to advisers and their firms to pay for ongoing client service. Fee-based advisers charge clients directly for advice, so they don’t need the trailing commission.
DIY investors are obvious customers for F-class funds as well because they get no investment advice and thus should not pay a trailing commission. Yet Qtrade seems to be the only online broker to offer F-class funds, and even there the selection is limited to a small and motley group of 38 funds.
“It’s modest for sure,” said Scott Gibner, Qtrade’s CEO. “This is a bit of a toe-dipping for us. We’re trying to get a feel for what type of appetite there is for this.”
Most of Qtrade’s F-class offerings are in the OceanRock and Meritas fund families, which are part of the Qtrade corporate family. But there are also a few funds from industry kingpins like CI, Dynamic, Fidelity, Mackenzie and Templeton. The F-class fund selection covers all the major portfolio building blocks, including Canadian, U.S. and international markets (I will publish the full list of Qtrade’s F-class offerings on my Facebook personal finance page on Monday.
Mr. Gibner said the drawback for online brokers in offering F-class funds is that they forgo money made through trailing commissions. A solution here would be to charge clients a fee, maybe $25, to buy and sell F-class funds. Savvy investors would understand that the $25 fee is chump change in comparison to the money wasted in buying mutual funds that pay trailing commissions to their online broker. Note: The largest Canadian equity funds have management expense ratios in the area of 2 per cent on average, and a full percentage point of that is accounted for by the trailer.
