Pressure mounts for funds to trim fees
Canadian investors are turning up pressure on the financial industry to be transparent about the fees they charge, and to adopt a fiduciary responsibility of putting the well-being of the investor ahead of selling products that pay advisers the most compensation.
Malcolm Hamilton, an actuary and pension consultant with Mercer Human Resource Consulting, has devised The Rule of 40.
Dividing the number 40 by the annual management expense ratio (MER) that your mutual fund charges will tell you how long it takes for fees to eat up one-third of your initial investment. With the average Canadian mutual fund charging an annual MER of 2.06 per cent, an investment of $300,000 would be reduced $100,000 by fees in 19.4 years.
The Canadian Securities Administrators, an umbrella group of provincial and territorial security commissions, recently released a discussion paper considering regulatory changes to address the lack of investor understanding of fund costs, conflicts of interest by mutual fund companies and advisers, alignment of adviser payment with services provided, and low-cost options for do-ityourself investors.
Also, the Investment Regulatory Organization of Canada just issued a comment paper suggesting that business titles and financial designations be aligned with how rigorous the study curriculum is, ethics, continuing education, examination, discipline and reputation of the organization issuing the designation.
Funds may have a front-end load or back-end load, namely commissions charged to buy or sell them. And they usually have an annual MER, which is a catch-all charge for items such as administration and research costs, office expenses, taxes, plus “trailer fees.”
Fund companies pay the ongoing trailer fees to advisers supposedly for providing client advice, which may or may not occur, and to compensate advisers for getting clients to invest in company products.
The CSA paper noted that “a greater reliance by advisers on trailing commissions and sales commissions funded from mutual fund management fees seems to have led many of today’s investors to mistakenly believe there is no cost to purchasing or owning a mutual fund.”
The average Canadian financial adviser now earns 64 per cent of his or her income from mutual fund trailer fees, up from 27 per cent in 1996. The CSA suggests perhaps capping or eliminating annual trailer fees.
A 2007 Harvard Business School report of 46,500 funds showed Canada to have the highest fees among 18 countries. In a 2011 study by Morningstar Inc., Canada had the highest fees of 22 countries.
Morningstar refuted claims by the Canadian mutual fund industry that Canadian fees are high because other countries don’t pay distribution costs as Canada does through trailer fees, and that Canadian funds have lower front-end load charges, pay a significant value-added tax, and pay higher costs for transparency in reporting expenses. Morningstar did concede that a much larger U.S. marketplace enjoys lower costs due to economies of scale.