DON’T CHEER FEE DISCLOSURE RULES YET.
Finally. Canadians will soon get clarity on what they’re paying for investment advice, along with better information on performance. At least, that’s what the roll out of the investment industries’ CRM2 is meant to provide. The last phase officially rolled out July 15 but, in most cases, investors will only start to see the difference in early 2017 with their 2016 Annual Statements.
On many levels, the CRM2 regulations ( under the auspices of the provincial securities regulators, the Mutual Fund Dealers Association and the Investment Industry Regulators Organization of Canada) will achieve its goals: There will be more disclosure of fees and better disclosure of performance. There is no question that it represents progress. However, a real problem remains: The fees being disclosed only represent the amount paid either directly or indirectly by an investor to the dealer firm, which means you are only being told half of the story.
Think of it in terms of a shirt manufacturer and chain store. When you buy a shirt from the store, you might pay $ 10. Behind the scenes, the store might pay the manufacturer of the shirt $ 5 and then keep the other $ 5 to cover its costs and profit. As the customer, though, you clearly paid $10. Not according to CRM2; according to CRM2, in this scenario you only paid $5.
That’s because CRM2 will disclose fees paid to the dealer, but not fees paid to the manufacturer — in this case, the portfolio manager.
In some parts of the investment industry, the “dealer” and the “portfolio manager” are the same. In those cases, CRM2 will truly disclose all fees. This is typically the case at a discretionary management firm. However, when people buy mutual funds, there is often a fee of maybe two per cent charged on the fund. Similar to the store in our example, a portion of that two per cent fee is paid out to another group.
In this case, the mutual fund company receives the two per cent, and then may pay out between 0.5 per cent and one per cent as a trailer fee ( depending on the fund) to the firm that sold you the mutual fund. That firm then keeps some of the one per cent and pays out the rest to the adviser who sold you the fund. Therefore, your fee disclosure statement under CRM2 will tell you that you paid only 0.5 per cent to one per cent, when in fact you paid two per cent.
The logic behind this is that investors can find the total investment manager/ fund manager fees elsewhere, and that to better understand the total cost of a mutual fund, investors can review the fund’s management expense ratio (MER). They can, of course, find this in a Fund Facts document or online. While this all sounds great, and new rules earlier this year will improve Fund Facts communication, study after study still show that a quarter of mutual fund investors believe they pay nothing, and another quarter don’t really know what they pay.
Here’s a crazy idea: Why not disclose all the fees in one place?
To make the new rules even more confusing, what if you are a Big Bank customer buying the Big Bank’s mutual fund? Last I checked, the Big Banks controlled the majority of the mutual fund market in Canada, so this may be relevant to Canadian invest- ors. Since the Big Bank owns the investment management arm and much of the distribution arm ( bank employees), even if all of your fee goes to the bank, you don’t know how the bank will split those fees internally. Here’s why it will now matter to you: Just because both divisions are part of the same company doesn’t mean you will be shown how much you paid in total. Instead, you will only see how much the ‘Big Bank dealer’ was paid, at least based on the statement under CRM2 rules.
To better explain, let’s go back to the shirt example. Let’s say that instead of the store buying the shirt from an independent shirt manufacturer, it decides to set up its own company called Shop Shirts. The store used to pay the shirt company $ 5 for their shirts, but how much does it now pay Shop Shirts? This becomes a question for the store’s CFO and finance department. Do they want to show that Shop Shirts is a great new profitable venture and therefore they pay $ 7 a shirt, or do they want to show that, through better business strategies, the store has cut the costs of shirts from $ 5 to $ 2? When you own both parts, you can pretty much decide whatever number makes sense.
So to use the store numbers for Big Bank mutual fund buyers: under CRM2, will you be told that you paid $ 10 ( the actual cost to you), $ 5 ( the cost that is “distributed” from the Big Bank investment arm to the Big Bank distribution arm), $ 7 ( if the Big Bank is allocating more money to the “financial planning and retail banking” arm this year), or $2 ( giving the investment management division better profits this year). If you were the Big Bank, and had to disclose fees paid to the dealer or distribution, which number would you use? Yeah, I would use $2 as well.
I am not saying that any Big Bank would do this, but why in the name of disclosure is this even a potential option? It also goes beyond the Big Banks. One of Canada’s largest independent mutual fund companies is mostly made up of advisers that sell funds managed by the company’s investment management arm.
To make matters worse, again, it confuses consumers. If you work with an investment counsellor, all the fees are disclosed. They were likely disclosed already, but because they are usually the ‘dealer’ and the ‘ investment manager,’ the total fee is clear. However, if you work with anyone who sells mutual funds, your statement will continue to be a convoluted view of what you actually pay.
How in the world does this help with fee disclosure and transparency to the consumer? In my view, there is a real risk that it makes things worse. Now, some investors will be told, “here is a report with all of the fees,” that nonetheless only shows part of the picture. Before, many mutual fund investors were in the dark on the fees they paid; now, what you pay is being disclosed — except for the part that isn’t included.
Like any good business, advisers provide a service for a fee. The customer then makes a decision on whether that service is worth it to them. For many Canadians, it is very worth it to work with financial advisers who provide not only investment solutions, but also broader advice around tax, retirement and estate planning, and can sometimes even offer advice on family law and eldercare issues.
What Canadians deserve is to know what they are paying for these services, and then they can make an informed choice.
Unfortunately, in parts of the investment industry, we are still not there yet.
WHY NOT DISCLOSE ALL THE FEES IN ONE PLACE?