Embedded compensation means clients who aren’t getting advice are paying for it anyway

By John De Goey | June 2004

The recent fiasco involving a discount broker who was forced to take F-class mutual funds “off the shelf” has the financial services industry talking out of both sides of its mouth. Everyone knows (but no one will admit) this happened because of pressure from advisors. I’ve had advisors boast to me about their role in this. Fund companies say they work on behalf of their beloved unitholders but, in fact, represent the interests of the advisors who recommend their products. Privately, advisors verify this perspective.

The great travesty of the financial services industry is that an entire generation of investors has spent the last number of years thinking financial advice was “free.” Of course, financial advice costs money, and rightfully so. But if financial advice costs money, then surely forgoing that advice should cost less money.

The arrogance of mutual fund companies with embedded compensation structures is astounding. They’re so convinced every last Canadian needs advice that they insist every last Canadian who uses their products be forced to pay for advice — even if there isn’t any advice involved. If they really were committed to the “advice channel,” they would either make their funds available on an F-class basis only, or simply refuse to allow anyone to purchase their products through a discount brokerage. That would make qualified advice a mandatory pre-condition of getting access to their product. As it now stands, consumers (even do-it-yourselfers) have to pay for advice, through trailing commissions paid to discount brokerages, whether they want it or not.

Take a moment to reflect on the practices of other established professions. People can “save money” by forgoing the services of an accountant and doing their own taxes. People can “save money” by forgoing the cost of a lawyer and representing themselves in a court of law. However, people cannot “save money” by forgoing the services of a financial advisor and making their own investment decisions — at least not with all the funds on the market.

I use quotation marks around the words “save money” because the argument put forward by many advisors and embedded compensation fund companies is that most people are better off using an advisor. I agree. I wouldn’t be an advisor if I didn’t. The difference is in the word “most.” Plenty of people do a fine job of doing their own tax returns without having to pay a professional.
Who are we to force them to pay for services they don’t use?

It seems mutual fund companies have such
a high opinion of financial advisors that they insist their valued clients pay for advice whether they want it or not. But here’s where the hypocrisy becomes ridiculous. If embedded compensation companies are so strongly committed to the advice channel, why do they pay every bit as much money to the non-advice channel? Is it rational to pay as much to people you “don’t prefer” as to the people you “prefer,” especially if the people you prefer offer additional and valuable services? Of course not.
Meanwhile, many advisors like this arrangement because they can now say it “costs no more” to get financial advice.
That’s a shame. It costs more to get tax advice or legal advice. Financial advice isn’t free, is it?

People strongly in favour of automobile airbags would happily pay more for a vehicle that had them than for one that didn’t. Those who are strongly in favour of energy-efficient appliances would surely pay more for that type of product. Why do fund companies with embedded compensation profess to be in favour of advice when they’re paying the non-advice channel every bit as much compensation? This is in spite of no work, no planning and no risk from the discounters, who earn fat margins as a result.

The only answer I can come up with is that the charade suits all the embedded compensation stakeholders very well. Fund companies like having another distribution channel with no liability and advisors (especially those who offer “load” mutual funds on a “no load” basis). And they like being able to say their advice costs no more than it would cost at a discount house.

The only group in all this that doesn’t like the status quo is do-it-yourself investors.
Remember them? Did the advisors who pressured the fund companies to remove their products ever think about protecting consumers? Many advisors are so focused on sales that they’re even dysfunctional with their own money. If anyone can explain the recent events to me with a compelling rationale other than the one stated here, I’d like to hear about it. Letters to the Editor written in response to this might also include the rationale of why advisors effectively bill themselves by buying mutual funds on an A-class basis for their own accounts.