By Dan Hallett, CFA, CFP
Type the phrase “financial advisor commissions” into Google and the results will be less than flattering to the financial advice industry. Understandably, regulators and the media are focused on full service brokers or financial advisors when this issue arises. But there is a good reason for both parties to cast their eyes on another closet door concealing a well-kept secret.
Advisor Commissions
Financial advisors that are licensed to sell mutual funds usually receive ongoing commissions known as ‘trailing’ or ‘service’ fees. They are paid out of a fund’s management fee to financial advisors and their firms in return for – at a minimum – servicing investor accounts and – ideally – for providing ongoing advice and ‘hand holding’ in tough times.
Much of the media exposure in recent years has centred on the global trend toward banning commissions and, in Canada, the battles to pull the veil on trailing and other commissions through better disclosure. All of the articles are consistent with the industry in calling trailing commissions payments for ongoing advice – hence the term ‘service fee’. And yet I rarely see articles questioning why discount brokers – which provide the most basic service – enjoy the same level of ‘service fees’ as their full service brethren.
Advisory Fees Without Advice
Investors buying load funds through discount brokers are paying for the services of a full service advisor. But they’re doing so through brokers that are prohibited from offering advice and that enjoy an exemption from the suitability assessment, which full service advisors are responsible for completing.
It’s clear, however, that such do-it-yourself investors aren’t buying these funds because they want to pay for advice that they’ll never get. They’re doing so because they want to invest in certain funds – often because of dazzling performance – and load funds are not available with a lower, commission-free MER.
So investors shoulder some blame for this situation. Indeed I argued in an older blog post that investors should stop buying pricey funds if they want lower fees. But there is a bigger problem with discount brokers.
I suspect that they’ve become accustomed to generous mutual fund trailer fees for providing basic execution and reporting. And they want to maintain the status quo. My recent experience with a big bank discount broker is a case in point.
My Discount ‘Advice’
I look after a few investment accounts as a favour to some friends and family members. For one such account, I went online to enter a trade to buy a fund that pays no trailing commission. I expect trading fees to apply when buying and/or selling such funds – as is the case with stocks and exchange traded funds. But my trade was rejected, so I phoned the brokerage.
I was told that the fund could only be purchased with a commission of 2% – $200 on the trade in question. I refused to complete the trade, expressing to the gentleman on the phone my preference for a similarly-cheap fund with no hefty purchase commission.
The so-called mutual fund expert on the phone proceeded to say that there are many good funds like the one I wanted. While acknowledging my desire for a lower fee he countered with, “Fees are important but if the returns are good, what do you care what the fees are”. When I kindly rebuffed his claim, he offered - without badgering from me – that the fund company in question had no “special arrangement” with the brokerage (read: they don’t pay us trailers) and, as such, is subject to what amounts to a front end load.
The Next Regulatory Priority
In the mid-1990s, AGF Limited fought to pay TD Waterhouse Discount (then bearing the “Greenline” moniker) a reduced trailer or nothing at all on its funds given that they provided no advice. While AGF wasn’t offering the savings to its end investors, it had a point. But they lost that fight.
Regulators are understandably and justifiably pressing the full service advisory industry for improved transparency - an important priority. But surely regulators want to curb efforts of discounters to point investors toward fully loaded funds so they can collect advice fees when they have neither the desire nor obligation to offer advice.
Dan, is there any way of learning what percentage of mutual fund assets is held within discount brokerage accounts?
My guess is there are not huge numbers of DIY investors buying A-series mutual funds. I would think the majority are buying individual securities, ETFs and D-series funds. But I have no data to back that up and might be way off base with that assumption.
There isn’t any publicly available data that I’ve seen on this. It strikes me as the kind of data point that Investor Economics might track. Another option is that paper from the Canadian Securities Administrators proposing a number of changes to the disclosure regime for advisor-client relationships. There are many figures and references to research that is being made public for the first time as far as I know. There may be something in there. I haven’t read it all yet.
I can only speak of my experience of having DIY investors show me their statements or homemade portfolio summaries over the years – and more than just the handful of accounts that I take care of for family and friends – and the interaction with other DIYs on the phone and via email. There are certainly more ETFs today in discount broker accounts compared to a decade ago. But I would bet that mutual funds remain a significant chunk of those assets. I don’t know how much.
But with one broker no longer offering true no load funds and another charging a fat up from commission while verbally directing investors toward full trailer funds, I’d bet it’s a bigger asset base than people realize.
I have to say, however, that I’m directing people wanting to invest in funds more toward Scotia iTrade today for its breadth of product offering on the fund side of things and for its lack of trading commissions on funds (and some ETFs).
The latest CSA document on the issue of trailing commissions is full of interesting stats on the matter, most if them issued by INvestor Economics actually.
in Figure 2 : Retail investment fund assets under administration by distribution channel, all the data is there.
Direct to pulbic is 28 g$ or 3 % of MF AUM in Canada, Discount is 4 % and branch Direct is 11 % .
http://www.osc.gov.on.ca/documents/en/Securities-Category8/csa_2012123_81-407_rfc-mutual-fund-fees.pdf
Note also that the document does a substantial job of dissecting the evolution of commissions and how it affects business models of many companies.
Et voilà.
And thanks Dan for the lesson on AGF/TD Battle.
Cheers all,
jfp
Thank you and you’re welcome Jean Francois.
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Can you give us the name of the 2 problematic brokerages? Thank you.
I am one of those “suckers” who has mutual funds with high MER and 5.0% sales commission charge paid to my financial advisor, and a 0.5% trailing commission for the 1st 6 years of my “Redemption charge purchase option”, then 1.0% after that for the time I hold the fund. Fortunately, I have been reading about the TD E series funds from Mr. Canadian Couch Potato(thank you sir), and have since opened a TD Waterhouse account. I am now in the process of trying to figure out what the fund manager is going to do with these dealer commissions. Any thought as to how I should proceed?
Thanks for taking the time to post a comment and question Cory. Hopefully you received some decent advice whether it was help in designing an asset mix strategy, selection of investments or just getting you to focus on putting a plan together and following through.
If one or more of these items applied to you and your purchase of DSC funds, then rest assured that it wasn’t a total loss. And even if you received nothing but a sales call, well I suppose it’s expensive tuition.
If you’re willing and able to handle your investments on your own – the tough part is the emotions/discipline not the selection of investments – then TD e series index funds or cheap broad based ETFs are compelling. Just be aware of the potential fees and expenses that go along with a lack of discipline. Because I concluded long ago that only disciplined DIYs actually benefit from the cost advantage of index funds and the vast majority of DIYs don’t fit this description. You may be an exception.
As for your discount broker, the firm needs to be compensated for being in this capital intensive business. There are lots of regulations that apply to discounters though they don’t need to ensure suitability of investments you purchase. But what we don’t want is a situation where trailers to discounters are outlawed and discounters charge fees separately that are as much or more than the trailers they’ve given up. It’s possible, though I have to think that competition would keep this from persisting for very long.
All to say that depending on the account size, an average trailer fee of 10 to 25 basis points seems reasonable so to the extent that you have a blend of investments – some that pay trailers and others that don’t – you may well be paying your discount broker a reasonable commission overall.
If you have a boat load of load funds still tied to that 6 year redemption schedule, then start taking your annual 10% free withdrawals. And see if you can reduce your fees by switching to cheaper funds in the same family. Almost every fund company has some lower fee alternatives.
Hey Dan, thanks for the quick response and good advice. I am going to switch to a another fund in the same family and start reducing by 10%.
I am probably more frustrated at myself originally, for trusting that my financial advisor would have my best interest in mind; I don’t believe this was the case. Then, when I decided to move the funds to a self directed account, I assumed that these trailing commission/fees (which are paid, for financial advice) would be waved somehow. Lol, apparently this is not the case, as you obviously know, because I just talked to a TD Waterhouse Fund Specialist, and after 15 minutes of ‘double talk’ she finally confirmed that TD Waterhouse will now get the trailing commission.
Oh well, live and learn
… thanks again Dan.