CSA report finds fund commissions have an impact on sales, returns

Specifically, the report notes that, “Trailer fees increase new flows regardless of past performance. Generally, the greater the trailer fee, the greater the level of net flows that has no relationship to past performance. For example, a 1.5% trailer fee increases the average monthly flows by 0.3% of AUM each month regardless of past performance.”

This diminished relationship between past performance and net flows seems to hurt returns. Notably, the research found that, “As past performance becomes less influential on fund sales, so too is there a reduction in future fund performance.”

The CSA’s research also found that an increase in trailer fees corresponds to a decrease in performance and that a decrease in trailers corresponds to an increase in performance. For example, for standalone mutual funds that are purchased through dealers, “an increase in trailer fees and deferred sales charges by 1% is indirectly associated with a reduction in future alpha by 1.4% and 0.6% relative to the average monthly alpha, respectively.”

Conversely, the research also discovered that investors who use fee-based accounts rather than commissions-driven accounts appear to fare better: “For mutual fund sales through fee-based purchase options, fund sales are highly influenced by past performance, and this positively impacts future fund performance.”

Finally, the research indicates that mutual fund sales through affiliated dealers also appear to have weaker connections to past performance, which is associated with weaker future returns.

“For mutual fund sales through fund distributors that are affiliates of the fund manufacturer, past performance has little to no influence on sales, and this also negatively impacts future fund performance,” the CSA’s report states. “Funds that were in the top quartile in terms of receiving affiliated dealer flows on average experienced a reduction in future monthly alpha by 0.2% relative to those funds that did not receive any affiliated dealer flows.”

The research was carried out by a team of academics from the Schulich School of Business at York University in Toronto, led by professor Douglas Cumming, and including his co-authors, Sofia Johan and Yelin Zhang. The CSA notes that the results are based on Professor Cumming’s analysis of detailed mutual fund data that was obtained directly from the mutual fund companies themselves.

Only 43 of 113 mutual fund manufacturers that were contacted by the researchers actually provided data, but this represented 67% of total mutual fund assets. The fund firms that did participate in the research exercise provided 73 data points for every fund series/purchase option combination they offered between Jan. 1, 2003 and Oct. 31, 2014, the CSA notes.

What’s not yet clear is what, if anything, the regulators will decide to do with the results. The CSA has been considering several possible reforms, including banning trailer commissions, among other measures, to address the evident conflict of interest created by the use of embedded commissions. But on Thursday, the CSA said it is aiming to “communicate a policy direction on mutual fund fees by the first half of 2016.”

The CSA’s research released follows another report released in June, which looked at how fee-based vs commissions-based compensation impacts investment outcomes. That report was based on a literature review carried out by the Brondesbury Group. Both sets of research were commissioned by the CSA following a paper published by the regulators in late 2012 that looked at possible regulatory concerns with existing mutual fund fee structures and consultations with the investment industry and investors that regulators carried out in 2013.

“Both studies and the comments received during the previous consultation period are intended to be among the inputs that will be factored into the CSA’s determination of whether to effect certain policy changes,” said Louis Morisset, the CSA’s chairman and president and CEO of the Autorité des marchés financiers.