Reform of mutual fund fees is essential for Canadians’ retirement security as the existing fee structure is unclear, conflicted and incomprehensible to consumers, resulting in high costs, poor consumer outcomes and a lack of effective price competition.
There are more than 12 million Canadians who own mutual funds, with some $900 billion in assets under management; but, at the same time, Canadians pay some of the highest mutual fund fees in the world. Thus, a clear and non-conflicted fee structure is desperately needed to increase price competition and make fees easier for clients to understand. Canadians deserve to receive unbiased financial advice and to have fund managers compete for investors’ hard-earned dollars through healthy competition.
First and foremost, the cost of financial advice should be charged separately from the cost of the financial product. Paying fees for advice separately and directly would allow for real price competition and result in a demand for better services and lower costs to consumers. This will encourage an efficient market as competition would be stimulated to provide consumers with advice and products that serve their needs. In turn, clients will be more likely to assess whether the services and advice they receive justify the fees paid. Advisors who provide the best services and products will benefit — and competitive forces will result in a more professional financial services industry.
Without misaligned incentives distorting the advice provided, the Canadian Foundation for Advancement of Investor Rights (FAIR Canada) expects low-cost index-based investments to be more frequently recommended over high-cost actively-managed ones. In fact, an overwhelming body of research demonstrates that low-cost index-based investing outperforms active management over the longer-term.
As a result of this proposed change, clients will receive more objective, better-quality advice that will improve their returns over the longer term. Small differences in costs have a huge impact on savings over time. (It is important that financial advisors be able to offer these low-cost products to consumers. Accordingly, FAIR Canada recommends that registrants who are permitted to sell mutual funds also be permitted to sell exchange-traded funds, if they meet proficiency requirements, to provide access to a wider selection of low-fee products.)
Under the cost and performance reporting reforms that will be implemented in the future, clients will eventually be provided with disclosure that tells them that they will pay an ongoing commission (the trailing commission) for as long as they hold the mutual fund for the “services and advice” provided. They will also receive a statement that provides them with the total amount of the trailing commissions the firm has received.
Although these reforms are beneficial, they will not get at the root of the problem, so clients will still find the fee structure incomprehensible, comparison of mutual funds difficult, and they will not be in a position to negotiate fees. Effective price competition will not come into play because third-party payments will continue.
There’s ample research and real-life experience to prove that disclosure of conflicts of interest does not lead to better advice or better decision-making. Even when conflicts of interest are disclosed to consumers, they’re not equipped to properly factor such information into their investment decisions.
Numerous surveys of consumers demonstrate a blind trust in financial advisors and a near-complete disregard for any effect that a conflict of interest may have on the advice provided. In fact, they believe their financial advisors will look out for their best interests regardless of how they are paid. Furthermore, research on disclosure points to perverse effects of disclosure, including increased reliance on conflicted advice and moral license.
The obvious solution is to eliminate the conflicts of interest between financial advisors and consumers. Banning trailing commissions and charging clients directly for financial advice will reduce conflicts. The sky will not fall in. Clients will pay their advisors rather than the mutual fund product manufacturers who incent sales through high fees.
As a result, embedded fees will no longer skew product recommendations. Clients will be better positioned to assess whether the services and advice their advisors provide justify the fees. Competition will be stimulated to provide value to consumers and, as a result, new, innovative and more cost-effective ways of delivering financial advice to consumers will emerge.