Why it's hard to hope for mutual fund fee reform

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Anyone gunning for changes to the way Canadian investment advisers get paid, particularly for peddling mutual funds, is supposed to be excited about the new, national agreement to fix the current system. I can't help but feel disappointed.

What started in 2012 as a full-throated review of embedded fund commissions has devolved into a small circus of sorts.

Who knows now whether charges such as trailer fees, which usually cost 1 per cent annually and are paid to the adviser simply for keeping someone invested in a certain fund, will ever be outlawed.

Amid early outcry from industry and its lobby groups, regulators commissioned two independent studies on the impact of embedded fees in order to cover their butts.

These took two years to complete, and in the end, merely confirmed what we already knew: Embedded fees distort which funds get purchased.

So it's a little depressing to find out that now, 31/2 years after the review was launched, the 13 provincial securities regulators have done little more than unanimously agree to study new proposals. June's announcement sounds promising, but all it really means is that we're staring down the barrel of another consultation paper this fall. Riveting stuff.

It would be different if the regulators had banded together to propose something really bold, such as banning adviser commissions of all types, putting Canada in line with Britain and Australia. In those countries, brokers can only charge hourly rates, a fixed fee, percentage charges or a combination of all three; there are no commissions for buying or selling individual securities, and no extra trailer fees paid on top of that. Everything is transparent. That would be a dramatic step worthy of extra study.

But in Canada, all the regulators are supporting, it seems, is something similar to what was already on the table – potentially outlawing embedded mutual fund charges. The only real change is that they've now unanimously agreed to do something together. We'll be lucky if we get a final draft of fixes in another four years.

I probably sound like a crank, but it's baffling because regulators have the empirical evidence they need. After the industry pushed back the first time, the provincial regulators hired Brondesbury Group to study existing literature on embedded fees. They found that commissions, including embedded fees, have the "best-documented negative impact" on investor outcomes.

The next paper, known as the Cumming report, studied Canadian data from 66 per cent of the country's total mutual fund assets and concluded that trailer fees distort the flow of money into mutual funds. In a world where investors should be investing money in funds that perform the best, trailer fees "give rise to more flow regardless of performance." The same was true for deferred sales charges.

Despite that evidence, the naysayers argue that regulators are biting off too much at same time. The industry is supposedly still bracing itself for the implementation of what is known as CRM2, which ensures commissions paid to advisers are fully disclosed to investors.

Look closely, though, and you'll see the smart industry players, such as CI Financial Corp., accepted these changes long ago. They're already onto the next thing, which is embracing low-fee products, such as exchange-traded funds. Demand is so heavy for them that scores of new ETF providers, from WisdomTree to Hamilton Capital to Sphere, are starting to sell them in Canada.

What our regulators seem to forget is that it's nearly impossible to make everyone happy. That's just the nature of policy. No serious change is ever easy. If you feel strongly about something, and have the data to justify the shift, you have to put your head down and push it through.

For myriad reasons, our regulators have lollygagged on adviser reform for so long that we're now woefully behind the times. While they still wrestle with what constitutes working in a client's "best interest," the entire market has changed, and the banks have come to dominate it. The pressing issue today is whether they push too many of their own proprietary funds on investors, all but killing independents in the process, and we don't seem close to even talking about it.

All regulators need to remember is the simple math. The U.S. Securities and Exchange Commission found that over 20 years, a 1-per-cent fee on an assumed 4-per-cent average annual return cut the total gain by 15 per cent. The effect is only more dramatic the longer the timeline.

That alone should do enough to suggest trailer fees, which usually cost 1 per cent, are a serious problem. And still, I have my doubts for reform. Prove me wrong.