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Don’t put off this important conversation with your advisor until the new fee disclosure rules take effect in 2016, and find out what you’re getting for your money.

Getty Images/iStockphoto

In an industry not known for its snappy prose, but CIBC World Markets Inc. analysts Robert Sedran and Paul Holden know how to write a catchy headline. "Trailer fees – the meteor is closer than you think" was the title of a recent note put out by Mr. Sedran and Mr. Holden. The meteor in question is a ban on trailer fees.

"Regulators are studying the impact of these fees, with the results of those studies and a recommendation expected early 2015. A ban on trailer fees would follow a global trend and would address the regulators' conflict of interest concerns. We think such a ban is coming, and sooner than many think."

Trailer fees can make up a huge chunk of the income of the salesperson who sold you a mutual fund. Morningstar defines a trailer fee as an "annual service commission paid by the mutual fund company to the sales representative. These fees generally range between 0.25 and 1 per cent and are paid out of the fund's management expenses." Most mutual fund companies charge trailer fees and, love 'em or hate 'em, they are simply a cost of doing business as a mutual fund investor in Canada.

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The big knock against trailer fees is that despite the advisor having a fiduciary duty to put the client in the product that best serves their needs, there is a financial incentive for the advisor to sell the client the fund with the highest trailer fee – a glaring conflict of interest.

New disclosure rules are coming into effect in 2016 in Canada that will make it incumbent upon the advisor to spell out how much they stand to make in fees when they sell a client an individual fund. The advisors will also be obliged to give you that documentation in plain English. That information should also allow you to see how your fund's trailer fee compares to competing products on the market.

But some in the industry have argued that these disclosure rules don't go far enough, and that trailer fees should be banned entirely. The ramifications of scrapping trailer fees would be wide-reaching. For the investment advisor, there's the question of how they will make up a potentially huge hole in their revenue. Mr. Sedran and Mr. Holden say the industry will likely transition to a model where advisors would be paid for managing a client's entire portfolio, similar to how financial planners are paid today. Furthermore, under such a model, the advisor's compensation would be tied to whether their client's portfolio appreciates in value. The implication is that it will also be in the advisor's interest to put clients into the funds they believe will perform the best over time.

The bigger players, such as the Canadian banks who already have vast mutual fund sales forces in branches, should be able to manage the transition just fine, according to Mr. Sedran and Mr. Holden. "The critical success factors of today (scale, distribution, competitive pricing and diversified products) will become increasingly important."

The co-authors say AGF Management Ltd. is at a major disadvantage, however, because it lacks that kind of scale. He says the company's "lone hope rests with the product shelf, and even that is not where it needs to be."

IGM Financial Inc. meantime which is already experiencing sluggish growth "will face more margin pressure than others"

Independent fund company CI Investments Inc., according to Mr. Sedran and Mr. Holden, is "the best positioned to actually gain market share, CI has a very strong product shelf that should support continued sales in a more competitive environment."

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Another effect of a ban on trailer fees could be the entrant of new players into the already very crowded Canadian mutual fund industry. Vanguard Group Inc., which oversees $3-trillion (U.S.) in assets, has indicated scrapping trailer fees could entice it to move into Canada.

Atul Tiwari, managing director of Vanguard Investments Canada Inc., says that since Vanguard doesn't pay trailer fees, advisors currently have little incentive to distribute its mutual funds, which is one of the reasons the company doesn't sell its mutual funds in Canada. But he conceded that "Sometime down the road we would definitely consider mutual funds as a product in Canada." Vanguard has quickly built up market share in the Canadian exchange traded fund (ETF) industry, by offering a broad swath of funds with an emphasis on rock bottom fees. Should this behemoth enter the Canadian mutual fund industry it will at the very least exert pressure on its competitors to lower fees. That's playing out in a big way in the ETF industry.

Joanne Xiao, analyst, active strategies manager research, with Morningstar Research Inc. isn't convinced Canadian regulators will end up eliminating trailer fees entirely. But she would like to see trailer fees abolished in one area that clearly irks her – fees for investors that buy mutual funds through discount brokerage accounts. Under the current system, if you buy fund "XYZ" using a discount brokerage, you pay a trailer fee but you get no investment advice specifically tailored to your needs. A trailer fee is supposed to be a service commission. That means a person should be providing the client ongoing services such as answering questions about performance, etc.

Ms. Xiao adds that if you buy the same "XYZ" fund from a sales person in a bank branch, there will be an advice component to the sale. Your mutual fund might not end up being a winner, but at least you are interacting with a human. That's worth something, right?

Editor's note: A previously published version of this article stated that Robert Sedran was the author of the CIBC World Markets Inc. report. In fact the report was co-authored by Mr. Sedran and Paul Holden, who is also a CIBC analyst.

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