Where do you get your financial advice? Is it the same place you get your specific investment or insurance advice and recommendations?
And how do you pay for that advice? By that, I mean do you write a cheque in return for an invoice? Or is an amount deducted from your investment account? Is it a more indirect payment?
Or are you unsure?
The regulators of the investment industry want to try to reduce the number of financial consumers who are unsure, and they are also considering eliminating any indirect payments (“embedded commissions”) for advice and products.
The Canadian Securities Administrators (CSA) represents all securities commissions in the country, and sets policy for the investment industry.
The CSA has floated a discussion paper on the future of embedded commissions, the most common of which are trailer fees paid by mutual fund companies to investment dealerships and representatives.
Trailer fees were the result of two decades of evolution of compensation methods for paying mutual fund salespeople. Prior to 1987, when the Industrial Horizons Fund introduced Deferred Sales Commissions (DSCs) to the industry, front end loads were the method of commissions. Front end loads were a direct deduction from the amount of money invested, and could be as high as 9%. Ouch.
DSCs were an improvement, but they can result in a cash charge to the consumer if money is moved out of the fund family prior to the expiry of the DSC period, typically 3-5 years now, versus seven years when DSCs were introduced. A problem with DSCs is that they were not always visible or understood by consumers.
The current evolution of mutual fund compensation is trailer fees (amounts paid to dealers and reps out of the internal management fees charged by the mutual fund) and to fee-based accounts, where a visible amount is deducted monthly to pay for the advice and admin costs of the dealer and representative. Fee-based accounts use F-Class mutual funds, which have lower costs and no trailer commissions.
Most industry observers and consumer advocates agree that the visible fees, separated from the internal costs of investment products, is the better route. It removes any potential bias that an advisor might have to recommend products that pay more, and the consumer can always determine the amount they are paying for advice.
However, embedded commissions have many supporters, with the most prevalent argument being that trailer fees and DSCs allow small investors to access advice and products that would be out of reach if they had to actually pay from their pockets the cost of these things.
As well, when publishing performance figures, fund companies show the returns achieved after the deduction of such internal costs and embedded commissions.
In the responses to the CSA discussion paper, I was shocked (not!) to see that a ban on embedded commissions is opposed by fund companies that pay embedded fees, and by trade associations like Advocis, whose members use them, but a ban is strongly supported by fund companies and ETF providers that do not pay embedded commissions.
Even the proponents of a ban acknowledge that there may be unintended consequences, such as a shortage of advice for young people and small investors, but they feel that the removal of product bias or perceived bias, and the increased transparency resulting, makes it worthwhile. As well, they point out that technology is making it easier for investors to “do it themselves”.
For my part, I have always favoured and advocated for the transparent model, choosing way back in 1994 to start only charging fees directly and visibly, and refusing all external commissions or compensation. So, while my bias (and my clients’ preference) is clearly toward transparency, I’m still not sure that a regulated ban on embedded commissions is the best thing for all consumers. I always favour choice.
We will see what the CSA concludes later this year.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax, insurance and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is recipient of the FELLOW OF FPSCTM Distinction, a portfolio manager and senior advisor with Christianson Wealth Advisors, a Senior Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.