RE: “Embedded Fees: A comparison” (Investment Executive, Mid-October 2017)

This recent editorial drew attention to research that Strategic Insight conducted on behalf of the Investment Funds Institute of Canada (IFIC). [The research] shows the costs of investing in mutual funds for investors in Canada who have a financial advisor are comparable to the costs for similar investors in the U.S.

Although IFIC is pleased to see Investment Executive cover these important findings, our organization is puzzled by the editorial’s conclusion that fee comparability means the Canadian investment industry should abandon its support of investor choice in paying for financial advice.

The study examines and compares the cost of ownership for Canadian and American investors who purchase actively managed mutual funds through an advisor. It doesn’t address how revenue flows to the firms and offers no evidence to support the editorial’s conjecture that advisors would earn the same under both compensation arrangements – nor, for that matter, why dealers’ and advisors’ revenue should be the basis for determining regulatory policy.

What the report does show is that the average total cost of ownership of actively managed mutual funds for clients using advice-based distribution channels in Canada was 1.96% (excluding taxes) compared with 1.95% for clients investing in actively managed mutual funds in the U.S., which doesn’t levy taxes.

The editorial assumes that the costs for investors in Canada and the U.S. will continue to be comparable if investors in Canada are forced to pay fees directly. This assumption ignores the reality that higher product costs in Canada, largely a function of lack of scale compared with the U.S., are offset by the lower distribution costs associated with embedded commissions.

There’s strong evidence that if Canada bans embedded commissions, many consumers of financial advice – especially those with less than $100,000 of investible assets – will no longer have access to such advice. Many other investors would probably pay more. Even in the U.S., costs for [investors with modest portfolios] are much higher than the average. The Strategic Insight study found that the cost of ownership in the U.S. is 2.3% for accounts of less than $100,000, roughly 17% higher than the average fee of 1.96% in Canada.

Although fee-based models dominate in the U.S., embedded commissions also are permitted. The U.S. market’s preference for fee-based advice in no way supports the editorial’s argument for banning embedded commissions in Canada. In both the U.S. and Canada, the advisors and their clients choose [the advisor’s compensation] model. Currently, the choices they’re making are resulting in comparable overall costs.

A ban on embedded commissions is no silver bullet. All compensation models carry the potential for conflicts of interest. Some proponents of a ban on embedded commissions argue that advisors on a fee-based model are more likely to recommend cheaper products, thereby offsetting the higher costs of advice for investors.

This may be true, but it doesn’t address conflicts of interest. Rather, banning embedded commissions trades one potential conflict for another. For example, under a fee-based model, advisors’ interests may conflict with their clients’ if the advisor recommends products based on their low cost rather than on their suitability in order to make the overall client costs appear competitive.

Regulators should minimize the likelihood that the risk of harm in conflicted compensation arrangements is crystallized. Contrary to the editorial’s statement, regulators have not yet made a convincing case that a ban on embedded commissions is a proportionate response to the harm they have identified.

A recent review of sales practices conducted by the Autorité des marchés financiers found good industry compliance and little evidence that advisors are putting their interests ahead of their clients. Previous reviews from the Mutual Fund Dealers Association of Canada and the Investment Industry Regulatory Organization of Canada support this conclusion.

IFIC members believe that the best way to minimize the likelihood of harm is to make disclosure more effective, ensure consistent enforcement of the self-regulatory organizations’ conflict of interest rules and incorporate those rules into regulations.

Paul Bourque
President and CEO,
Investment Funds Institute of Canada

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