Industry: Ban could hurt smaller clients

Some representatives of the fund-management and dealer industries say that small investors could be hurt by any ban on embedded trailer fees for mutual fund products if they’re faced with separate advisory fees instead.

If the trailer fee is banned, investors could pay an advisory fee based on a percentage of invested assets, a separate fee for financial planning advice or forgo advice altogether by dealing with a discount broker.

Although new regulatory initiatives are pushing Canada’s mutual fund industry toward fuller disclosure of the actual dollar amounts paid by investors in the form of trailer fees, some participants at a recent Ontario Securities Commission roundtable discussion argued that regulators should take a stronger stand and abolish trailer fees. Others argued strongly for the preservation of choice in the payment of advisory fees, including embedded or bundled fees.

Joanne De Laurentiis, president and CEO of the Toronto-based Investment Funds Institute of Canada, told the roundtable that embedded commissions such as trailer fees give small investors the most efficient and economical access to advice. If fees for advice are negotiated by small investors on an individual basis, she said, these investors may end up paying more as a percentage of assets than do holders of high net-worth accounts or be ignored entirely.

If advisors have to bill each investor for small amounts of money, De Laurentiis suggested, they’re going to “skew toward the higher account. The embedded commission does [give the advisor an incentive] to seek out smaller accounts. If investors have no place to go with the first $10,000 when they start to invest, what happens there? I think that’s a question we can’t lose sight of. Those individuals may, in fact, not ever invest.”

Beyond the roundtable, many other industry participants have strong opinions. In an open letter to the industry, Brendan Caldwell, president of Toronto-based Caldwell Investment Management Ltd., points to studies in the U.S. by Boston-based consulting firm Dalbar Inc. that found that mutual funds sold directly to clients without the benefit of a financial advisor have an average holding period of only 12 months. Most self-directed investors trade funds based on short-term performance instead of holding their units until the money is needed, with the result that many of their individual long-term returns are considerably less than those of the funds they invest in.

Trailer fees and the accompanying guidance from advisors, according to Caldwell, counteract the “wealth-destructive switching that occurs when investors are left to their own devices,” or when the primary source of compensation for advisors is a sales commission derived from making a mutual fund switch.

“Trading funds gets investors into trouble,” Caldwell’s letter continues. “It seems obvious that mutual funds should be structured in such a way as to encourage continuity and to discourage trading.”

Fee-based advisory accounts, Caldwell’s letter suggests, are “marvellous” for active traders but may encourage the same short-term trading behaviour that is detrimental to most investors.