The end of the trailer fee may be nigh. But so far, the Canadian mutual fund industry hasn't taken major steps to prepare for that scenario.
As part of a multi-year review of compensation in the financial services industry, securities regulators are looking at whether an overhaul in mutual fund trailer fees is necessary. A recommendation, expected early in 2015 could see the industry moving away from paying advisors trailing commissions for their services, and to a fee-based model instead. In October, CIBC World Markets Inc.analysts Robert Sedran and Paul Holden in a report entitled "Trailer fees – the meteor is closer than you think" argued that an outright ban on trailer fees is coming.
The vast majority of mutual funds in Canada are still sold on a trailing commission basis, where advisors are paid commissions by the fund manufacturer. As of Dec. 31, 2013 of the $1-trillion invested in mutual funds in Canada, only $55-billion or just over 5 per cent, was invested in F-series products i.e. sold to an investor in a fee-based account. That's up a little since the end of 2011, when only 2.6 per cent of Canadian mutual fund sales were F series. The industry is moving towards a fee-based model in Canada, but at a glacial pace.
The mutual fund industry in the U.S. has largely moved away from trailer fees. Ward Ring, managing director, wealth consulting with RBC Wealth Management says, "The move towards the fee-based model started 10 to 12 years ago. It's fairly far down the path and it's growing considerably." There are regulatory imposed limits on mutual fund fees in the U.S. that cap most trailers at 0.25 percent. Another key driver has been the rapid-fire rise in popularity of exchange traded funds (ETFs), which do not carry trailers. Mr. Ring added that the introduction of commission-free, "F" series mutual funds for institutional clients, also exerted downward pressure on trailer fees. He says financial services companies in the U.S. increasingly started offering fee-based advice, because investment advisors were having a hard time eking out a living exclusively on trailers. Only 30 percent of RBC Wealth Management's equity mutual funds sales in the U.S. are sold via trailing commissions; the other 70 percent originate from fee-based advisors.
In Canada, the growth of the ETF industry and the possibility of an outright ban on trailer fees, has prompted some investment advisors to start dipping their toes into offering fee-based advice. Assets in fee-based accounts at RBC Wealth Management Canada increased by 19 per cent in 2013 compared to 2012. "Most astute firms and advisors are looking and saying, something's going to give with this and we had better get ahead of the curve" said Guy Armstrong, senior consultant and managing director, with Investor Economics.
A fee-based model won't necessarily result in investors paying less for advice; in some cases investors may end up paying more. The bigger point is that transparency will go up. A common criticism of the current regime is sometimes investors are unaware they are even paying trailer fees. (Full disclosure: When I purchased my first mutual fund in the late 1990s, I had no clue what a trailer fee was.) However under a fee-based model, a client would have the ability to haggle face-to-face with an advisor on fees. Those with larger portfolios should be able to push for lower fees, than someone with a smaller portfolio.
Even if trailers aren't abolished, new disclosure rules coming into effect in 2016 in Canada will make it incumbent upon the advisor to spell out in plain English how much they stand to make in fees when they sell a client a fund. Mr. Armstrong says that although change is good for the industry, he isn't convinced investors' behaviour will change. "Maybe clients will continue to throw their statements in the garbage and nobody will notice, and nobody will care."