Disingenuous Arguments from Mutual Fund Lobbyists

Report on OSC Fees Roundtable

“If there’s anything in the whole world of mutual funds that you can take to the bank, it is that the expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds.” Russell Kinnel, Morningstar 
“Under plausible conditions, a person saving for retirement who chooses low-cost investments could have a standard of living throughout retirement more than 20 percent higher than that of a comparable investor in high-cost investments.” William F. Sharpe, Nobel laureate

At the OSC’s Mutual Fund Fees Roundtable, held on June 7, 2013, retail investor-focused representatives took members of the mutual fund industry to task for their refusal to acknowledge that reform is needed to address the high, opaque, and conflicted fees associated with many Canadian mutual funds. Strong representation by investor representative groups and investor-friendly members of the financial industry refuted and challenged weak, self-serving industry lobbyist arguments.

FAIR Canada participated in the first panel, and continued to stress the need to remove the conflicts of interest from the current remuneration structure for the sale of mutual funds which can lead to poor investment recommendations for consumers and higher costs.

The following is an overview of some of the interesting points that were raised during the four hour-long roundtable discussion. FAIR Canada sincerely thanks the OSC for hosting this informative event, and encourages meaningful progress on this important initiative.

Conflicts of Interest

FAIR Canada found it disappointing that some members of the mutual fund industry refuse to acknowledge that commission incentives influence the sale of mutual fund products. As summed up by one industry participant who favours a ban on third-party embedded commissions: “… compensation drives advice and that embedded-compensation causes bias… it is widely accepted as a self-evident truth that embedded compensation causes bias.” Another industry panelist who advocates for the continued use of trailing commissions, admitted that “…compensation does have a minor, I guess, impact on the advice channel…” while suggesting that, generally, most funds pay a “standard” 1% trailing commission.

In response to industry representatives’ pleas to wait to see the implications of other initiatives underway in Canada, including the Client Relationship Model (CRM) and Point of Sale (POS) disclosure for mutual funds, Commissioners were cautioned that disclosure does not go to the root of the problem. CRM and POS will not address the misaligned incentives imposed by third-party commissions and, therefore, consumers will still be subject to higher-than-average fees, poor advice and distribution of inferior products due to incentives central to the current mutual fund fee structure.

It was also pointed out that, in addition to the U.K. and Australia, developments to ban distribution fees are underway in European jurisdictions, including Germany and the Netherlands, and that the E.U. is working on an initiative expected to be introduced in approximately two years for broader implementation. Early observations from the U.K. are also that prices are coming down and access is increasing. Canada is lagging behind.

What Do Trailing Commissions Pay For?

Embedded commissions are paid by third party product manufacturers out of investors’ funds without any reference to the actual services provided. Consumers are charged the trailing fee even if services are not provided.

Industry representatives were reluctant to clearly explain what trailing commissions pay for. Commissioners noted “ducking and weaving” in response to such questions. While a very lengthy list of possible services was recited, it was unclear precisely what consumers pay for through trailing commissions. We question how there can be healthy competition for “advice” when industry cannot explain what services they will provide in exchange for the embedded fee consumers pay each and every year.

Industry-representative panelists were also questioned about the growing prominence of expensive fund-of-funds, which involve less work for advisors but pay higher trailing commissions. Industry representatives evaded answering the question and instead replied that through selling various products they are able to generate enough fees in order to provide services to the client.

High Fees Compared to Other Jurisdictions

Industry lobby groups’ biased reports, including the Investment Funds Institute of Canada’s report on the cost of ownership, that suggest that the costs in the U.S. and Canada are comparable, were robustly challenged. One industry representative provided strong refutation of claims that U.S. fees are comparable to Canadian fees once you factor in the cost of fee-based advice. It was noted that, in the U.S., they are observing lower-cost products entering into these fee-based accounts. FAIR Canada believes that this illustrates the expected outcomes of direct payment for advice: investors are receiving better (i.e. unbiased) advice and are benefitting from lower costs. It is not just the cost of the advice that is relevant, but also the cost of the product sold to the consumer.

Further, Commissioners were reminded that Morningstar’s latest Global Fund Investor Experience Report again gave Canada the only “F” grade for fees of all the countries assessed.

Advice for Lower-Net Worth Clients

OSC Commissioners pushed industry representatives to explain their argument that charging fees directly (instead of indirect, third-party, sales-based compensation) would shut out smaller clients. The question that was posed was why advisors’ behaviour would change if advisors were being paid directly by the client rather than indirectly by fund manufacturers. It was argued by industry representatives that advisors’ behaviour would not change, but at the same time it was suggested that in a fee-based environment advisors start customizing and catering to individual clients. Eventually it was admitted that “…the services are different; therefore, the fees are different.”

FAIR Canada believes that this admission confirms our expectation that, if people pay mutual fund advisor fees directly, Canadian consumers will be more aware of the costs and will ensure that they receive value for the fees they pay. We anticipate that this will drive innovative service models to provide more efficient, low-cost investment advice, as has been the early experience of other jurisdictions that have moved to ban embedded commissions.

It was also pointed out that, irrespective of whether the advisor was being paid directly or through embedded commissions, if the client was not economical for the advisor to take on advisors would not choose to provide services to such a client. The method of compensation does not change the access for smaller investors. In FAIR Canada’s opinion, small investors are not well served in the current structure, and will be better off under a transparent fee structure.


OSC Commissioners heard that changes to deal with the problems presented by embedded commissions need to be initiated sooner rather than later. It was pointed out that, given the seven year time horizon of some embedded commissions, even if changes were made today it would take seven years before embedded commissions could be totally banned in Canada.

Industry scare tactics like “unintended consequences” were also relied upon to dissuade regulators from taking action. Investor representatives commented that the unintended consequence could just as likely be unintended positive outcomes for Canadian investors, and encouraged the OSC to take steps to move this initiative along, while observing and considering developments in other jurisdictions as it does so.

Click here for the complete transcript of the entire discussion.

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June 26, 2013