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Canada's investment community will be required to be more transparent with clients about the cost of financial advice starting this summer, but not all fees will be completely exposed – including the breakdown of trailing commissions.
A heated debate is under way in the wealth management industry on whether asset managers should still pay these commissions, also known as trailer fees, to financial advisers who sell mutual funds. At the same time, regulators are sharpening their focus, sending strong signals that these fees that advisers have counted on for decades could soon undergo significant reform.
Some in the industry are advocating an outright ban on the use of trailers by asset managers, forcing investors to pay upfront for the advice they receive from an adviser. Similar to how a lawyer or medical specialist might run their business, investors could receive an invoice with a dollar amount owing for a service provided.
Trailing commissions are a portion of a fund's management expense ratio (MER). The commissions are paid out to investment advisers for the length of time an investor holds a fund. Depending on the type of investment fund, these can range from 0.5 per cent up to 1.5 per cent. Both the investment firm and its adviser who sold the fund share in these commissions.
"Trailer fees are the least understood topic for investors," Pramod Udiaver, chief executive officer at online portfolio manager Invisor Investment Management Inc. of Oakville, Ont., says. "Most of the time, when we look at our clients assets from other institutions, that is when they become aware they have funds linked to deferred sales charges and trailing commissions. It is completely unbeknownst to them. Everything is embedded and it isn't clear to them."
With the arrival this summer of the second phase of the client relationship model, or CRM2, industry regulators have mandated greater transparency of fees in the mutual fund industry. While the trailing commission will be shown in a section called "charges and compensation," the document will not provide a breakdown of how much the trailing commission is paid to the financial adviser and how much is kept by the investment firm.
A 2015 report by Investor Economics found that 86 per cent of equity and balanced funds sold in Canada paid trailer fees of 1 per cent for front-end and no load options. An additional 9 per cent of the funds paid fees above 1 per cent. (A front-end load fund pays an adviser a commission at the time of purchase, while a back-end load fund pays a commission when the investor sells the fund.)
One of the biggest concerns within the industry is whether the presence of trailing commissions creates a conflict of interest for financial advisers when recommending funds, as well as whether a higher-than-normal trailing commission persuades an adviser to choose one over the lower paying fund.
Securities regulators across Canada were expected to publish a broader discussion paper on mutual fund fees earlier this year, but that has now been pushed to the fall. The paper will lay out a small number of options for reform, "with a strong recommendation" for what the next steps will be, Ontario Securities Commission chair Maureen Jensen said in an interview with The Globe and Mail.
Ms. Jensen said investors should be able to trust that their advisers are recommending the best mutual funds for their needs, "not the one he knows has more of a percentage return for him."
She favours a new regime "that reduces or eliminates" conflicts that advisers have when they offer recommendations to their clients.
"I don't believe that we should put forward an option that tinkers around the edge," she said.
Last fall, a study titled "A Dissection of Mutual Fund Fees, Flows and Performance" was commissioned by the Canadian Securities Administration to assess whether sales fees and trailing commissions influence mutual fund sales.
Lead researcher, Douglas Cummings, who is also the Ontario research chair at the Schulich School of Business at York University, determined that trailer fees did have an impact on mutual funds sales. He found those funds that pay trailer fees to financial advisers attract higher inflows of cash from investors, even when they perform badly, and that those funds tend to perform worse overall than other funds.
"Generally, the greater the trailer fee, the greater the level of net flows that has no relationship to past performance," writes Mr. Cummings in the report. "For example, a 1.5 per cent trailer fee increases the average monthly flows by 0.3 per cent of assets under management each month regardless of past performance."
Whether or not the report will lead to an outright ban is still up in the air.
Greg Pollock, chief executive officer of Advocis, an industry association for financial advisers, says banning commissions could do more harm to the average Canadian investors than good, leaving many Canadians without affordable access to investment advice.
"We are not opposed to fees – whether its hourly fees or fees based on assets under management – but what we see is the vast majority of Canadians are paying for financial advice through an embedded compensation/commission structure" Mr. Pollock says.
"We believe that if the industry removes the option for embedded compensation – it will lead to far less advice for the average Canadian. Similar to the legal industry where there are individuals not preparing a will because of the upfront fee that they don't want to pay."
Some are suggesting a more subtle approach than an outright ban. Peter Intraglini, CEO of fund company Invesco Canada Ltd., recommends a solution that would impose a regulatory cap of 1 per cent for the industry.
"In recent years, a handful of mutual fund companies have increased trailing commissions beyond the industry standard of 1 per cent in order to gain market share," he said in a statement last fall. "If all fund companies pay the same trailing commission, the perceived conflict of interest– that advisers might recommend a fund because it pays them more– would be fully eliminated," Mr. Intraglini said.
The debate has already driven some asset managers to drop fees over the past year. This past winter, Sentry Investments made fee reductions on all its equity, balanced and fixed income funds for front-end purchase options. Known in the industry for higher-than-average trailing commissions of 1.25 per cent, the reduction saw all front-end trailers drop to 1 per cent or lower.
The use by asset managers of higher-than-average trailing commissions was a common tactic that came about in the 1990's from smaller fund companies looking to compete against the giants of the fund industry, notes Dan Hallett, principal with HighView Financial Group.
"But in today's environment, every instance of 'above-market' trailing commission that I can think of appears to be motivated by wanting to stoke sales of those funds," Mr. Hallett says.
"CRM2 is on the right track but it does need to be pushed a bit further in the transparency department," he says.
While some industry players are advocating simply requiring more detailed disclosures about the payments advisers receive from mutual fund companies, Ms. Jensen of the Ontario Securities Commission said she doesn't believe that is enough to resolve inherent conflicts because investors don't read technical details.
"These documents have become documents that protect the issuer and are nothing about communication to the client," she said.
With a contribution from reporter Janet McFarland