Possible Ban on Trailing Commissions in Canada
The Canadian Securities Administrators (CSA) has issued a proposal to ban mutual fund embedded commissions. This would force financial advisors to charge their clients directly instead of getting commissions from the mutual funds that hold their clients’ investments. Whether this makes sense depends on how we view the mutual fund industry.
There are two extreme narratives that characterize the fund industry in Canada. Which one you think is closer to the mark will likely decide whether you support CSA’s proposed changes.
Narrative 1: Financial advisors are hard-working professionals who must be paid for the initial work they do for their clients and must be paid a lesser amount each year for their ongoing work helping their clients. Paying the advisors out of client assets within mutual funds is just a convenient way to complete the transaction with a minimum of hassle for clients.
Narrative 2: Mutual funds that pay trailing commissions know that investors are clueless about costs and have conspired with advisors to increase fees to punishing levels and split the spoils. The embedded commission model is designed to keep investors in the dark.
Obviously, there is some truth in both narratives. But which one dominates? As the latest changes to the Client Relationship Model (known as CRM2) come into full effect, no doubt reality will be pushed somewhat away from Narrative 2, but how much? Is CRM2 enough or do we need to ban embedded commissions entirely?
My own opinion is that there is too much truth in narrative 2. There are certainly some good pockets within Canada’s mutual fund industry, but banning embedded commissions is needed. If it happens, it will cause big changes.
There are two extreme narratives that characterize the fund industry in Canada. Which one you think is closer to the mark will likely decide whether you support CSA’s proposed changes.
Narrative 1: Financial advisors are hard-working professionals who must be paid for the initial work they do for their clients and must be paid a lesser amount each year for their ongoing work helping their clients. Paying the advisors out of client assets within mutual funds is just a convenient way to complete the transaction with a minimum of hassle for clients.
Narrative 2: Mutual funds that pay trailing commissions know that investors are clueless about costs and have conspired with advisors to increase fees to punishing levels and split the spoils. The embedded commission model is designed to keep investors in the dark.
Obviously, there is some truth in both narratives. But which one dominates? As the latest changes to the Client Relationship Model (known as CRM2) come into full effect, no doubt reality will be pushed somewhat away from Narrative 2, but how much? Is CRM2 enough or do we need to ban embedded commissions entirely?
My own opinion is that there is too much truth in narrative 2. There are certainly some good pockets within Canada’s mutual fund industry, but banning embedded commissions is needed. If it happens, it will cause big changes.
I am much more fond of the wording in Narrative 2, but I am also biased. Narrative 1, has a ring of truth in that financial advisors need to be paid, but a more transparent method would give me more confidence in the entire system.
ReplyDelete@Alan: I'm not sure that you are biased. Having an opinion is not the same as being biased. Narrative 1 is about deserving to be paid rather than needing to be paid. Narrative 2 is about not deserving to be paid. I'm sure there are financial advisors and mutual funds fitting both narratives.
DeleteThe very simple questions should be:
ReplyDeleteWhy are there trailing commissions?
What benefit do they create for the client?
It's kinda like taking your car in for an annual tune-up, paying the mechanic, but also having the insurance company apply a hidden 'mechanic fee' onto your insurance rate, which funnels back to the garage.
It's painfully obvious that a lot of the current state of financial sector is holdover from the old-school client fleecing days of yore; finance is still hugely incentive driven (remember, it was the financial insiders who initially rejected the creation of the index fund because it cut into their commissions). Hopefully this kind of shake-up, even if it doesn't go through at max effect, will usher in a new era of intelligent financial players with a new way of thinking and sink the bloated sharks who cannot adapt. (As well as waking up investors to the fact that costs matter -- a lot.)
I have no problem with advisors et al charging as many fees as they see fit -- as long the client has 100% transparency to each and every fee so they can decide if that service/product is worth the money.
With nary a professional money manager beating the market with any kind of regularity/longevity, the investor should ask their advisor as directly as possible, "Why are you charging me 2% every year when I can pay 0.5% for the same (or better) result?"
That's my biased opinion. :)
@SST: Fixing this mess depends on how well clients understand their choices and the costs of these choices. Making clients explicitly dig into their pockets to pay advisors is a good start. Hopefully, that will remove the incentive for advisors to pick expensive mutual funds for their clients.
DeleteEven after 22 years in the investment industry, I can't quantify the relative sizes of the two groups represented by narratives 1 and 2. So I know the industry is full of product pushers. But there are tens of thousands of "advisors". So even if 5% of 50,000 advisors are 'bad apples' that's 2,500 people. And since we hear more about negative outcomes, that's a lot of damage to be inflicted by 2,500 people when you consider that advisors probably average 300 or so clients each.
ReplyDeleteAnd I'm always surprised by how confused people are about investing. I have very smart/educated friends/relatives asking me for help and it's because they don't have the time to spend hours and hours (for a couple of years) riding the learning curve. So I believe that most people need help and they need to be prepared to pay for it. But it's long overdue for the industry to be up front about what it charges clients - before clients decide to hire the advisor.
@Dan: I agree with you that being up front about charges is long overdue. You may be right that only 5% of advisors are the true bad apples. However, the system of hidden high mutual fund fees where the spoils are split with advisors is corrupt. This leads to a large percentage of advisors who have good intentions ending up not acting in the interests of their clients. The main problem has never been that advisors are bad people.
Delete@Dan, every honest advisor must be happy to come out of the shade and differentiate their offering by charging a fee for service, not a commission from amount.
Delete@AnatoliN: It sounds like you and Dan are on the same side of this issue.
DeleteThose who are both honest and forward-thinking already have (though some are hand-cuffed by compliance officers). I was part of a team that helped create an online system to calculate portfolio costs in % and $ in 1997! (Not a typo...almost 20 years ago.)
DeleteI continued that work in early 2000s when working with a dedicated MFDA dealer. And the advisors I worked with then and subsequently through the 2000s welcomed the transparency I helped them create. But some didn't like it and were afraid it would expose their big secret. Again, tough to quantify the sizes of the groups.
But given that the industry has failed to come up with a solution on its own, it's fair to say that it's a large influential contingent...though they've lost their influence. Regulators are pushing forward and it's overdue.
@Dan: There is definitely a strong minority of advisors and funds seeking to improve the system. I agree that regulation is overdue.
Delete"So even if 5% of 50,000 advisors are 'bad apples' that's 2,500 people."
DeleteIs it a case of bad apples or that of a bad barrel (and the perfect environment for creating bad apples)?
MJ sure likes to stir the pot with these topics!
@SST: I think it's some of each, but the bad barrel is the bigger issue.
DeleteJust to add, pleas don't forget the "MLM" style investment companies. I think we know who they are without me mentioning their names and watching this discussion fall off a cliff fast.
ReplyDeleteThese are the worst kinds of "advice" peddlers. There has to be 2500 in every city. IMO this is a far worse problem. You have people with zero financial knowledge, passing on their mistakes to the most vulnerable.
Taking these types out of the picture with these changes is a big step forward.
@Paul: I agree that there are some companies that seem to specialize in maximizing conflicts of interest. Disrupting their business models will help people.
Delete