Research on clients’ attitudes toward embedded vs non-embedded mutual fund fees, currently being conducted by Invesco Canada Ltd., supports giving clients the choice.
The Toronto-based investment fund firm is conducting an ongoing survey of financial advisors, investors and clients on this issue. Recent initiatives by regulators mean that all fees related to mutual funds will have to be fully disclosed to investors by the middle of 2016, with regulators also considering a ban on embedded fees. About 87% of advisors who have responded to the Invesco survey said that they earn income from commissions, most of it embedded.
The Invesco survey is asking investors about their understanding of mutual fund fees and their preferences on how they pay these fees. Survey participants watch two videos on “bundled” (embedded) and “direct” (fully transparent) fee structures, says Peter Intraligi, president of Invesco Canada, then fill out an online survey that includes questions such as did the survey participant understand mutual fund fees prior to watching the video, did their advisor ever explain mutual fund fees to them and the general breakdown of their investments.
While the survey findings are preliminary, Intraligi says, 80% of respondents so far have stated that they prefer embedded compensation to a direct fee. More than 750 investors and clients have responded to the Invesco survey to date.
From Intraligi’s point of view, investor interest in the embedded compensation model signals that clients want choice in how they pay fees rather than a ban on embedded fees. Such a ban would have unintended consequences for smaller clients, Intraligi adds, such as limiting their advice options. Choice, he says, means having a variety of options available for clients, from embedded compensation to fee-for-service.
Furthermore, the rollout of the new fee-disclosure requirements in the second phase of the client relationship model (CRM 2), says Intraligi, will provide clients with the information they need to make their own choices around fees: “[CRM 2] will go a long way to help educate and create more transparency and awareness around fees, which enables the investors to make conscious decisions on their own, which they really want.”
The survey is the second phase of a research initiative conducted by Invesco this year. Over the summer, Invesco reported on the results of its survey of advisors. That survey asked 2,669 respondents to provide a breakdown of their books and the fees they receive from mutual funds.
Among those fees, the top 20% of clients – those with an average mutual fund account size of $222,935 – pay average total fees and commissions of about 1% of the client’s average assets under administration, or about $221 per month.
The remaining 80% of clients, those with an average mutual fund account size of $76,699, pay average total fees and commissions of about 1.07%, or about $81 per month in commissions.
The monthly commission goes to the dealership, with advisors receiving a portion of those fees. Looking at these numbers, Intraligi argues, fees are fair, given the services that advisors provide, such as retirement and investment planning. Adds Intraligi: “That’s pretty exceptional value when you consider what that advisor is doing for that client.”
Joanne De Laurentiis, president and CEO of Toronto-based Investment Funds Institute of Canada, agrees with Intraligi that transparency around embedded compensation, not an outright ban, is the best option for investors. The CRM2 rules, she says, require advisors to explain fees to clients from the start of the relationship.
The new performance reporting and account statement requirements also will help, she adds: “That really gives a powerful tool to the investor. It isn’t just a disclosure component; it’s giving [clients] a lot of information about what they got for those fees.”
Those who advocate the banning of embedded compensation, however, argue that transparency is not enough and that conflicts of interest remain. For advisors, says Marian Passmore, associate director, Canadian Foundation for Advancement of Investor Rights, that conflict is in the temptation to propose a mutual fund to a client that might be suitable but is not the best recommendation, simply because the fund has a higher fee than other options.
Passmore argues that getting rid of trailer fees will lead to lower pricing options for investors. “If you get rid of that structure and [clients] pay directly,” she says, “then you allow for price competition actually to occur, which will benefit the consumer and make it a more competitive industry.”
In an open letter to the financial services sector last month, Intraligi acknowledges gaps in the current fee structure. He conceded the need for some changes to the current compensation structure regarding do-it-yourself (DIY) investing. The issue, he says, is that DIY investors who purchase mutual funds are paying for advice they are not receiving.
“Rather than disrupting millions of Canadian investors [by banning embedded fees],” Intraligi suggests in his letter, “we propose that mutual fund companies work together with online brokers to reduce the embedded costs paid by DIY investors.”
© 2013 Investment Executive. All rights reserved.