Resurgence may embolden regulators

This should be the best of times for the Canadian mutual fund industry. RRSP season is in full swing and assets under management (AUM) totals are soaring. But the industry should not lose sight of the fact that this resurgence may embolden critics and stiffen regulators’ spines.

The latest data from the Investment Funds Institute of Canada show that the fund industry finished 2013 just shy of $1 trillion in total AUM ($999.2 billion). Over the past year, AUM is up by about 17.6%, or almost $150 billion. Most of this has come from the new strength in the markets, but the industry did enjoy almost $42 billion in net sales during the year.

These higher AUM totals translate into increased revenue for fund companies and higher trailer commission revenue for dealers and financial advisors. The flip side of this good news is that it also illustrates the fundamental flaws at the heart of the fund industry’s fee structures, which critics have long bemoaned and regulators recently have noticed once again.

The Canadian Securities Administrators’ (CSA) recent consultation paper set out several regulatory concerns with the current industry fee structure, noting that trailers have grown to account for almost two-thirds of the average financial advisor’s book in recent years. The outsized importance of these fees represents a potential conflict of interest and highlights the disconnection between advisor compensation and client service.

These concerns are exacerbated in an environment of strong market returns. The CSA paper, released in late 2012, estimates industry revenue as of Dec. 31, 2011, from management expense ratios (MERs) to be $13.4 billion and from trailer fees to be $4.6 billion, based on total industry AUM of $762 billion. As industry AUM is up by more than 30% since 2011, it’s fair to assume that revenue and trailers have risen proportionally. That would put industry MER revenue at $17.4 billion in 2013, with trailers reaching $6 billion.

These rough estimates highlight the ultimate impact of market performance on dealer compensation, and may bolster some of the regulators’ concerns with the current fee structure. If fees are up by 30% over the past couple of years, policy-makers and regulators may well question whether clients now are getting 30% more value for their money.