MUTUAL FUND FEES DISCUSSION PAPER Q&A
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- Chrystal Fields
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1 Q&A The Canadian mutual fund industry may be facing some of the most significant regulatory changes it has seen in a long time. The changes some ready to be rolled out, some still under development and some at the discussion stage may, if fully adopted, impact your relationships with clients. To ensure you re up to speed on what s happening in the industry right now, we have produced the following Q&A. Q. What does the discussion paper regarding mutual fund fees examine? A. A discussion paper released in December 2012 titled CSA Discussion Paper Mutual Fund Fees examines the mutual fund fee structure in Canada. The Paper identifies perceived investor protection issues resulting from the current mutual fund fee structure and considers potential regulatory options to address the identified issues. The focus of the paper is sales charges and trailing commissions and, among the options discussed, regulators raised the possibility of banning trailing commissions. Other options discussed include: Requiring advisors to specify the services to be provided in exchange for trailer commissions. Creating lower-fee classes of fund units or shares for do-it-yourself investors that would pay reduced trailer commissions or none at all. Unbundling of the trailer commission from management fees and requiring it to be charged and disclosed as a separate asset-based fee. Separate series or classes of funds for each purchase option. Capping of trailer commissions. Implementing additional standards or duties for advisors. Q. Is what s happening in Canada right now the result of what is happening internationally? A. Right now this issue is only in the discussion stage, meaning that regulators are acknowledging the presence of potential issues and are seeking input from stakeholders and interested parties to determine if anything needs to be done. The CSA have been holding round table discussions with investors, financial advisors, dealers and mutual fund companies. The regulators are still collecting data to analyze whether or not changes are necessary to the mutual fund fees structure. Q. When will these changes come into effect? A. Right now this issue is only in the discussion stage, meaning that regulators are acknowledging the presence of potential issues and are seeking input from stakeholders and interested parties to determine if anything needs to be done. The CSA have been holding round table discussions with investors, financial advisors, dealers and mutual fund companies. The regulators are still collecting data to analyze whether or not changes are necessary to the mutual fund fees structure.
2 Q. Has anyone conducted an analysis showing the potential impact of these changes? A. We believe that some of the options considered in the Discussion Paper could have unintended consequences including limiting investor access to financial advice, which is of great concern to us. Unlevel Playing Field The fact that the Discussion Paper is focused solely on mutual funds implies that issues raised in the Paper are unique only to mutual funds, when in fact the same issues exist with other investment products, such as segregated funds. This sole focus also implies that the current regulatory regime for mutual funds presents a singularly high level of conflict of interest and risks to mutual fund investors when this is really not the case. The CSA need to include other investment products in their analysis, otherwise they may be implementing rules that could make mutual funds more difficult to sell than other products, creating an unlevel playing field and lead to market or product dislocations. Higher Costs for Investors The CSA believe that eliminating trailing commissions, as has been recently implemented in some international jurisdictions, will reduce costs for investors. We disagree and feel that some of the options considered in the Discussion Paper may drive the industry toward a fee-for-advice model, which could in fact result in higher costs for mutual fund investors. Additionally, with only a fee-for-advice model, the total cost is reported separately to each investor individually, and so the ability to compare total investor costs across different organizations is significantly reduced, which in turn results in less transparency in the industry. Creating an Advice Gap The Paper also states that under the fee-for-advice model it is typical for the total cost to rise as an investor account size decreases. This is due to the lack of economies of scale in servicing small accounts, which may result in many low and medium-income investors to lose access to affordable investment advice. Right now, the U.K., Australia and the U.S. are all in various stages of adopting reforms to their mutual fund industries. There have been a number of studies conducted in the U.K. to assess the impact of these fee reform initiatives. The results of these studies seem to indicate that: Small investors are losing access to advisory services because they cannot or will not pay for advice Pricing structures are becoming more complex and less transparent, which is the opposite of their intention Allianz Global Investors reported in February 2013 that there is evidence of an emerging mismatch between what investors are willing to pay and what advisors charge under a fee-based model. They call this an "Advice Gap". About 1-in-4 investors (27%) would be willing to pay up to 50 per hour for advice, whereas only 7% of advisors would work for this rate; Most advisors (86%) plan to charge between 100 and 200 per hour, but only 7% of investors would be willing to pay this; and 32% of investors would not be willing to pay separately and directly for advice. Also a Deloitte study released in November 2012 reported that many investors would be reluctant to pay advisor charges under a fee-based model: Some 33% of U.K. adults with less than 50,000 in savings, and 32% of those with more than 50,000, indicated that they would cease using advisors for all products if they were charged directly; and Some 56% suggested they are likely to reduce the number of times they use advisors if charged a fee of or 3% of their investment.
3 Q. Have sales charges and trailing commissions been increasing over the years? A. No. According to respected industry research firm Investor Economics, fund sales in the 1980s were dominated by the front-end load option, which could reach up to 9% of the initial investment in those days. Today, 98% 1 of mutual fund assets held by individual investors do not incur either acquisition or disposition costs neither front- or back-end loads. As a result of the changing trend, sales charges nowadays do not play a big role in the total cost of Canadian mutual fund ownership. Moreover, trailer fees paid to dealers have remained unchanged. In 2011, the average trailer fee paid by long-term funds was 78 basis points, virtually unchanged from the 77 basis points recorded in Q. One of the items the Discussion Paper examines is the possibility of unbundling trailing commissions from management fees and requiring them to be paid and disclosed separately. If that comes to pass, would it result in lower fees for investors? A. A major concern expressed by the industry is that if embedded fees are eliminated, investors may be pushed to a fee-for-advice model. Research shows that 0.02% Program Fee the process of unbundling (extracting the distribution cost component from the MER and replacing it with a negotiated fee levied at the account level) does not necessarily translate into significant investor cost Program Fee 0.96% efficiencies. In fact, it has been shown that the fee-for-advice compensation model could potentially result in higher 2.08% MER costs for mutual fund investors. The UK experience with unbundling is that pricing power has shifted increasingly to the distributor, with the result that investors and particularly small investors are now paying more for advice than they did previously. This is due to the lack MER 1.13% of economies of scale in servicing small accounts, which may result in many low- and medium-income investors to lose access to affordable investment advice. Furthermore, as you move away from the embedded fee model, you lose transparency and the comparative element present with an MER. Embedded fee structure 2.10% Source: Mutual Fund MERs and Cost to Customer in Canada: Measurement, Trends and Changing Perspectives, Investor Economics, 2012 The diagram on the right depicts the difference between a typical A-series mutual fund with embedded fee structure and a fee-based account such as an F-series mutual fund. The left column shows the average mutual fund cost of ownership when advice is paid for through a trailer fee. The average cost of ownership in the embedded model is 2.10%, compared to 2.09% when the distribution fee is paid on a fee-for-service basis. This represents a savings of only 1 basis point when fees are unbundled. Q. Can the two compensation models fee-for-advice and trailing commissions co-exist? Fee-based account 2.09% A. We believe they can. And we also believe investors should be free to choose the model that best works for them. Like many existing investment products, a product that is suitable for one investor may not be suitable for another. At the time of assessing suitability during the account opening process, it should be decided whether the investor's account is commission-based or fee-based. Like investment products, the commission-based model is suitable for some investors, while the fee-based model is more suitable for others. The CSA should not dictate that only one option is available.
4 Q. Does the potential introduction of some regulatory fee changes stem from the belief that it costs more to invest in mutual funds in Canada versus the United States? A. Recent discussions have compared the Canadian MER to the U.S. Total Expense Ratio (TER), which excludes distribution costs. Needless to say, the U.S. amount is lower because it does not represent a true picture of all of the costs in that market. The costs outlined for the U.S. are derived from the dominant fee-for-advice model in the U.S. and includes a range of external fees. When the TER is added to the distribution fees, the total cost becomes comparable between models. Specifically, on a tax-adjusted basis (as taxes are not embedded in U.S. mutual funds) the 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 MER 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%. Thus, on a before-tax basis, both models yield approximately the same costs to investors. 0.19% 2.02% Taxes Pre-tax cost of fund ownership Canada; All advice-giving channels 2.21% Fees external to TER Total Expense Ratio (TER) USA; Fee for advice % Source: Monitoring Trends in Mutual Fund Cost of Ownership and Expense Ratios, A Study by Investor Economics and Strategic Insight, % % Q. Is there evidence supporting the value of advice? A. At Dynamic Funds, we recognize the importance of reliable financial advice. Independent financial advisors are there to help investors manage their investment goals and assist them in developing financial plans to suit their unique circumstances. We believe the that best way for an investor to purchase a mutual fund or other investment product is through a qualified financial advisor who can assess the investor s needs, recommend appropriate products, and provide ongoing investment advice and assistance. Double the saving rate of non-advised Saving Rate Amount of Assets 4.2x more assets than non-advised Non-advised 4.3% Advised 8.6% Non-advised $24,000 Advised $101,000 Source: Value of Advice Report 2012, IFIC, Econometric Models on the Value of Advice of a Financial Advisor, CIRANO Institute
5 These benefits reveal themselves in a number of ways, including having a greater sense of control of one s finances, and the peace of mind that comes from greater confidence in the future. Advice allows investors a better chance of... Accumulating greater wealth through better savings behaviour Building assets for a more comfortable retirement Selecting tax-efficient investment vehicles Maintaining a long-term investment strategy Protecting against poor financial decisions Avoiding emotional investing habits In addition to the many positives accruing to investors who use the services of an Advisor perhaps the two biggest advantages are evidenced by the savings rate and asset growth between advised and non-advised households. As you can see on the previous page, investors who work with an advisor save at twice the rate and accumulate more than four times the assets than those who don t. Q. What are the next steps? A. The regulators have not formally implemented a change to legislation as findings from their public round table in 2013 indicated divergent views from industry stakeholders and investors. The OSC recently announced that they plan to undertake research to determine if the current fee structure truly does create a conflict of interest before proposing any changes contemplated in the discussion paper. The regulators expect the research to be completed in early Our efforts (i.e. lobbying, influencing, educating) reflect that this is still only a discussion paper and is not a proposal to amend current governing laws. Should the Discussion Paper turn into proposed legislative changes, or the CSA make it known that they will be moving forward with some of the proposed changes, our actions may become more significant. The management team at Dynamic Funds will continue to monitor the actions of the CSA and work with IFIC, other fund companies, dealers and the Canadian regulators. When opportunities arise, Dynamic Funds will actively promote the value of advice to the regulators and political figures in an effort to deter the changes raised in the discussion paper. 1 Investor Education Fund, Investor behaviour and beliefs: Advisor relationships and investor decision-making study. (The Brondesbury Group, 2012). 2 Mutual Fund MERs and cost to customer in Canada: Measurement, Trends and Changing Perspectives by Investor Economics. 13DWD116_DF_SUFA_MF_Fees_Q&A_EN_V4_DOP_0914 We have created a Standing up for Advice section at advisor.dynamic.ca which contains a wide range of useful information and resources particularly in the area of the value of advice. advisor.dynamic.ca Dynamic Funds is a registered trademark of its owner, used under license, and a division of 1832 Asset Management L.P. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
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