Commission-based compensation among financial advisers is creating problems within the industry that must be addressed, according to an industry report released last week by the Canadian Securities Administrators (CSA).
A mutual fund fee research report completed by the Brondesbury Group, and commissioned by the Ontario Securities Commission, reviewed existing research on mutual funds compensation and found that the impact of compensation is "conclusive enough to justify the development of new compensation policies."
The report was conducted as part of a larger industry initiative to determine whether mutual fund companies should ban the use of trailer commissions – a fee that is paid out to an investment adviser on an annual basis for the duration of time a client holds a mutual fund.
Canadian regulators are expected to make a decision regarding the banning of trailing commissions in early 2016.
The report found that all forms of adviser compensation affect advice and outcomes for investors; and while fee-based compensation is likely a better alternative, there is not enough evidence to state with certainty that it will lead to better long-term outcomes for investors.
"As a regulatory regime, we are really lagging behind the rest of the world in terms of fee disclosure and fiduciary duty," says Alan Fustey, managing principal and portfolio manager at Index Wealth Management Inc. in Winnipeg. "[The report findings] is leading us in the right direction and hopefully what we see next is more than just fee disclosure and a commission ban. They need to incorporate a fiduciary duty or a best-interest standard to the industry."
In addition, the report found investment advisers push investors into riskier funds and adviser recommendations are sometimes biased in favour of alternatives that generate more commission for the adviser. The report also notes that investors cannot determine what type of compensation is best for them and readily make "sub-optimal" choices.
When looking at investment outcomes over the long-term, it was found that mutual funds that pay a commission underperform. "Returns are lower than funds that don't pay commission whether looking at raw, risk-adjusted or after-fee returns," says the CSA paper.
While removing commission lowers product cost, advisory fees may rise as a means of paying for the cost of service. Investors could also see new or increased administrative fees, higher costs on margin accounts and lower payments on cash balances.
In certain jurisdictions, such as the U.K. or Australia, where regulation has been changed to ban or limit commission, there is evidence that this change affected investor outcomes. The report shows "in the absence of embedded compensation, advisers recommend lower-cost products that typically have better returns because of lower expenses."
At the same time, in jurisdictions that have moved to fee-based compensation, people with less wealth and less income find it harder to get financial advice than others (but there is no evidence that this is a change from the pre-regulation environment). In these cases, alternative offerings such as robo-advisers could start to accommodate the growing gap in advice.
Later this summer, York University Professor Douglas Cumming will submit a second research paper that will look at the influence of sales and trailer commissions on sales in the Canadian mutual fund industry.