September has come
and gone without the In-vestment Funds Institute of Canada making its promised “full public response” to the controversial study, Mutual Fund Fees Around the World, by Ajay Khorana, Henri Servaes and Peter Tufano, professors respectively from the Georgia Institute of Technology, the London Business School and the Harvard Business School.

The study found that, after adjusting for fund type, fund size, complex size and other variables, Canada charges the highest fees in the world, by far. The factors identified as contributing to the high cost of mutual funds are the quality of the legal system in general and investor protection in general. Greater investor protection is seen as relating to lower fees.

IFIC chairwoman Brenda Vince obliquely recognized these factors in her remarks at the IFIC annual conference, when she said the funds industry should not shy away from greater transparency, more competition and enhanced investor protection; and IFIC should encourage debate among members on issues that would enhance the industry’s competitiveness and long-term health.

Issues Vince singled out for debate are an expanded range of pricing options for mutual funds, more transparency in pricing and the value of advice and advisors.

If Vince’s objectives are going to be met, it will take more than just debate among IFIC members or the funds industry. It will have to involve governments, regulators and the investing public.

The reality is that high costs are eroding Canadians’ ability to accumulate sufficient assets to provide for their financial well-being. The competitive forces that normally work to produce the value proposition are simply not there. There are many reasons why.

If we are going to give credence to the much discussed and laudable goals of enhancing investor protection, fostering competition, increasing productivity and enhancing the financial and economic well-being of Canadians, we will have to address the factors that stand in the way.

The core issue to address is Canadians’ general lack of knowledge and awareness of financial and economic matters, and of cause and effect. This is aggravated by the knowledge gap between sellers/providers of financial products and advice and their customers/clients, as well as the unequal bargaining power of the customers/clients. Conventional remedies for this sorry state of affairs are education and disclosure. Governments, regulators and the funds industry have failed Canadians on both accounts.

Take disclosure. The lack of transparency of fees and charges, and the impact these fees and charges have on investors’ long-term total return is unconscionable. Disclosure of fee impact risk on long-term capital is crucial to levelling the playing field for investors. The delivery of disclosure materials to investors is also crucial.

Another factor leading to capital-eroding high costs is the regulatory decision to allow distribution costs to be charged to mutual funds. In addition to embedded sales commissions (trailer fees), this has led to the full cost of prospectuses and annual reports — including legal fees, printing and distribution costs — being charged to the mutual fund. These distribution costs represent a conflict between the manager (who is seeking new unitholders) and the fund’s existing unitholders. This conflict used to be kept in check by the regulatory requirement (no longer in effect) that a fund’s fees and charges could not exceed 1% of its net asset value.

Another factor undermining the discipline on fund managers to keep operating costs of funds under control is managers’ adoption of fee structures permitting them to add operating costs to the costs paid by unitholders. Many operating costs charged to funds are for services provided by related parties to managers without having been tendered for competitive bids. Fund operating costs will soon include costs of the independent review committees that will monitor managers’ conflicts of interest.

There are many other factors behind managers’ conflicts of interest and the value proposition of mutual funds. They need to be addressed from the unitholders’ perspective. Unitholders need a seat at the table. IE