For several years, canada’s mutual fund industry has been heavily criticized regarding the fees paid by clients. Much of this criticism is based on a 2006 U.S. analysis, which claimed that fees in Canada were much higher than in the U.S.
This analysis was flawed, as it did not take into account the critical differences between the two marketplaces. Nevertheless, the findings of the study were quoted and requoted, to the point where they were considered to be gospel.
Indeed, in the absence of sound evidence to the contrary, even some financial advisors and industry members accepted the notion that Canadian fees were higher.
Finally, a thorough analysis by two highly respected research firms has put these charges to rest. Toronto-based Investor Economics Inc., now a subsidiary of Asset International Inc. of New York, and another Asset International company, Strategic Insight, have collaborated on a comprehensive, fact-based comparison to establish the true total cost of ownership of mutual fund units in both countries, including:
– what it costs to acquire units in a fund, including commissions;
– ongoing costs, including trailer fees (whether embedded in the management expense ratio [MER] or paid separately by the investor); and,
– disposition costs.
Accounting for all of these factors is the only way to truly determine the true cost of ownership.
Using this thorough framework, along with a comprehensive analysis of all costs, the recent research revealed that the average cost of owning units in a mutual fund in Canada is virtually the same as it is for a typical investor using an advisor in the U.S. Specifically, on a tax-adjusted basis (there is no HST in the U.S.), the assetweighted cost of ownership in Canadian advice channels is estimated to be 2.02% of invested assets.
In comparison, U.S. fees (including those embedded in the published expense ratios and fees-for-advice paid separately by the investor) fall within a range of 1.7% to 2.4%, with an average cost of ownership of approximately 2%.
The recent report noted some key differences between the two countries. In Canada, advisor fees are embedded within funds’ MERs; in the U.S., compensation to advisors has mostly moved to fee-for-advice, charged to investors separately from the reported fund expenses. These fees are not published. As a result, they often are not included in MER/total expense ratio (TER) comparisons and seldom captured in analyses of investors’ total costs.
The research also found that for many advisor-assisted U.S. investors, unbundling of fees may have resulted in higher costs over the total life of the investment. By some estimates, roughly 60% of investors with account sizes of $100,000 pay between 1.0% and 1.5% for advice in addition to the published TER. Further, almost one-third pay more than 1.5%.
In addition, first-time investors are likely to pay much more for advice in a fee-for-service environment than through embedded compensation.
Unbundling of fees can lead to a serious “advice gap.” A Deloitte LLP survey of more than 2,000 adults in the U.K., where unbundling came into effect this past January, found that the change was prompting many people to opt out of seeking advice.
As a result, many advisors in the U.K. are focusing on serving wealthier clients. Deloitte predicts that up to 5.5 million investors 11% of the population will not have access to advice as a result of these regulatory changes.
The existing Canadian model serves investors well because they can readily identify their total costs and easily compare costs across funds. In the U.S., it is left to each advisor-assisted investor to estimate his/her total costs, and no benchmarking is available for comparing wealth managers. Investors need to deduct their advice fees from their reported rates of return to measure performance accurately.
There are other advantages to the Canadian model. All credible research shows that the savings discipline created for clients through the advisor produces superior financial results for the investor: the difference can be as much as 2.5 times more financial assets than households that do not receive financial advice after all costs are taken into account.
Without the savings discipline that is reinforced by having an advisor, unbundling may reduce the number of people who save for retirement, leaving them dependent on government programs later in life. Average and small investors will be affected the most.
Mutual funds were created to enable ordinary people with small amounts of capital to participate in a professionally managed, diversified investment plan. Prior to the creation of mutual funds, only the wealthy could access the services of expert portfolio managers to invest in the market.
The public-policy question is: should we turn back the clock and make advice available only to those who have much more to invest or encourage a range of competitive choices and let the investor decide?
Joanne De Laurentiis is president and CEO of The Investment Funds Institute of Canada.
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