In May 2017, the Investment Fund Institute of Canada (IFIC) recommended investment industry regulators provide rules governing embedded advisory fees charged by mutual funds.
The issue is that some mutual funds sold by online discount brokers charge an embedded advisory fee, and discount brokers do not provide advice.
Discount brokers play a useful role in the distribution of financial products for those who don’t seek financial advice, in order to avoid paying for it.
Being a self-directed investor is a choice, and that choice is to be respected.
Currently some mutual funds offered to do-it-yourself investors using discount brokerage platforms come with an embedded advisory service fee. That defeats the purpose.
Electing to forego financial advice in order to reduce fees is inconsistent with the current practice to be charged for advice not received.
Paul Bourque, the president and chief executive of IFIC offered his opinion:
“Investors who buy funds directly, for example through a discount broker, should be confident that they are not inadvertently overpaying by selecting a series (of mutual funds) that includes fees for services that are not available through that platform.”
According to IFIC, two thirds of Series A mutual funds sold in Canada have a management expense ratio of 2 to 2.5 per cent. Mutual funds sold without embedded service fees can have a management expense ratio as low as under 1 per cent.
There are two reasons to offer mutual funds without embedded financial advisory fees. The first, that we have covered, is some investors choose not to receive advice.
The second is to allow for financial advice to be charged separately. This is a more transparent method that is becoming more popular.
In that scenario, an advisor would charge a client a specific amount. Because the advisory fee has been charged, there is no need to have additional advisory fees included in any investment products purchased.
In early 2017, the Canadian Securities Administration released a paper that also proposed changes to embedded mutual fund charges. The chair of that organization, Louis Morisset, provided his comments.
“The CSA has identified three key issues stemming for the payment of embedded commissions. One of the issues identified is the fact that embedded commissions paid generally do not align with the services provided to investors. As an evidence of this issue, we have identified in [our paper] that discount brokers who provide execution-only services often distribute fund series that pay them the same trailing that would be paid to a full-service dealer.”
An idea that Morisset suggested is for investment dealers and advisors to charge directly for financial advice.
That would be the best solution and I for one would like to see this implemented.
Capitalism is all about the distribution of goods and services to customers at a specific price. Ongoing intense competition is a constant balancing act between the value of the good or service offered, and the price paid.
For financial consumers to be involved in the ebb and flow of capitalism they need to easily understand the cost of financial products and service. That way they can make informed decisions on what they purchase, or what they decide not to purchase.
Until we have a simple and transparent pricing mechanism, like virtually every other business transaction, the investment industry will not have the full advantages of a free market.