Time for ‘adviser series’ ETFs has come and gone

COMMENT

TETF Focus he inescapable conclusion of the OSC commissioned Cumming Report found that embedded compensation in mutual funds — also known as trailer fees — skew the flows into and out of those funds.

That report has led to calls for such fees to be banned in favour of a fully transparent model. This, incidentally has already come to pass in other jurisdictions, notably in the United Kingdom.

Here’s the problem in a nutshell: The incentive for the adviser to recommend a fund paying him or her a trailer fee as opposed to one that doesn’t at the onset is a given. But there is also the less obvious corollary, which is that once the fund is selected, as long as it keeps pumping out its embedded “advice” fee to the adviser, there is little incentive to switch funds.

At the best of times, inertia all too often prevails for investors — adding a compensation scheme that acts as a headwind to making changes only makes things worse.

What has t hat got to do with Exchange Traded Funds? As it turns out, many of the innovations pioneered by mutual funds ultimately found their way into the ETF market.

The problem of how to compensate advisers whose clients were commissionbased popped up many moons ago, as ETFs didn’t pay an annual trailer.

Enter “adviser series” ETFs, introduced in Canada — the only market in the world that offers them.

In the adviser series ETF case, the ETF has an additional fee, which gets subtracted from the assets of the Fund alongside its MER, and which subsequently gets remitted to the adviser.

You might presume the built-in incentive to sell these ETFs turned them into a runaway success story, but you’d be wrong.

Today, these ETFs, some 90 or so of them, represent less than 1 per cent of all ETF assets ($88.5 billion as at Feb. 29, 2016).

While the overall ETF industry saw aggregate assets rise by some $23.7 billion in the past two years, these adviser series ETFs sustained an AUM decline of close to 30 per cent.

It is just as well, and time for these ETFs to go. The adviser series version generally represent but a minor percentage of the ETF’s overall AUM, and in most, they don’t amount to much, either in per cent terms or in absolute dollar terms.

Eliminating adviser series ETFs represents an opportunity for the ETF industry to show leadership in the area of full fee transparency, a principal on which the industry has long prided itself.