I’ve been thinking about what I find most irksome from the defenders of the mutual fund status quo, especially the continued existence of trailing commissions. Here’s a look at my biggest concerns:
Terminology. Most proponents of mutual fund trailers refer to those trailers as “fees.” But trailers are commissions, plain and simple. There’s only so much lipstick you can put on this pig. Commissions are paid for placing products; fees are paid for giving professional advice. By way of illustration, discount brokerages do not (indeed, cannot) offer advice, yet they receive trailers. It follows that trailers can only be commissions.
Some people seem to want the credibility that comes with charging a fee without actually… you know… charging a separate, transparent fee. No dice.
Scalability double standard. It is widely accepted that it is simply not four times as much work to deal with a $1-million account as it is to deal with a $250,000 account. Thus, advisor compensation should be higher (in percentage terms) for smaller accounts than for larger ones. The mutual fund industry says that large investors are effectively subsidizing smaller ones. I agree.
If that is true, however, then it must also be true that mutual fund companies are overcharging large investors. The fund industry offers a zero-sum value proposition on more than just the cost differential between actively managed and passively-managed products.
It wants the virtuous spin of helping (and perhaps even protecting) small investors, but if the industry wants that credit, it also must accept responsibility for overcharging larger investors. The industry cannot have it both ways.
The issue here is fairness. If the industry is scalable and scalability is a rational and normal thing, then it follows that embedded compensation is fundamentally unfair due to its inherent lack of scalability. In fact, embedded compensation is like a reverse flat tax on investors.
Invesco Canada Ltd.’s April 2013 letter to the Ontario Securities Commission regarding comment on fund fees (81-407) made mention of this de facto subsidy. Then, in June, Caldwell Investment Management Ltd. CEO Brendan Caldwell wrote in an op-ed piece in the Financial Post: “Whether you have a million dollars or a thousand dollars in a particular mutual fund, the same rate is used and the same percentage of your assets is paid to your advisor…. Do the fees generated by large investors in mutual funds subsidize smaller investors? Absolutely.”
My rejoinder: “If you have more than $250,000 invested in actively managed mutual funds, are you paying too much? Absolutely.”
Product recommendations. Some financial advisors offer only products with embedded compensation to their clients, then say that their clients “prefer” to do business that way. More often, clients are not given a real choice. There still are tens of thousands of advisors who effectively say, “You can have any product you like – provided that it pays me an embedded compensation.”
An advisor’s preferred business model should not be the main driver of product recommendations. This will be especially true if the client’s best interests truly have to come first.
There are other benefits to eliminating trailing commissions. These include the deductibility of advisory fees in non-registered accounts through section 20(1)(bb) of the Income Tax Act, the directability of having higher-income earners pay the associated fees for family members (like income splitting, only for fees), and the fact that fees for registered plans can be paid from outside the registered account, allowing for maximized tax-deferred compounding within that account.
How many thousands of investors don’t know how or how much their advisor is paid? Is that good for consumer protection? Would it even be possible if embedded compensation was eliminated?
The time has come. Canada is already behind a number of countries in doing away with something that has outlived its defensibility. Let’s just get this done.IE
John De Goey, CFP, Fellow of FPSC, is vice president and associate portfolio manager with Burgeonvest-Bick Securities Ltd. (BBSL) of Toronto. The opinions expressed are not necessarily shared by BBSL.
© 2014 Investment Executive. All rights reserved.