Details

Category: Newsletters

Published: 08 September 2017

Hits: 6682

Guaranteed Investment Certificates – dull – but interesting!

updated December 29 2025

 GIC FAQ - Frequently Asked Questions

For many investors, Canada’s most boring investment has to be a GIC (Guaranteed Investment Certificate). If you were thinking Canada Savings Bonds – they were eliminated in the 2017 federal budget. However, is GICs dull reputation truly deserved?

Lately, there has been renewed interest about this safe, dull-as-grass investment...

Question: What is a GIC?

Answer: A GIC is generally described to be a term deposit with a Canadian bank, trust company, credit union or Caisse populaire. The term can be anywhere from a 30 day term to a term of 5 years (sometimes longer). The “G” in GIC stands for “guaranteed” but guaranteed by whom? In the case of an insolvency of the financial institution that issued the GIC, GICs in Canada have a depositor protection program. For example, the Canadian Deposit Insurance Corporation (CDIC) is the federal government agency responsible for chartered banks and trust companies in Canada. In the case of insolvency/bankruptcy, the government agency ensures that eligible GIC investors are paid their full principle (up to certain maximum limits) along with any accrued interest owing. 

GICs issued by credit unions are regulated under provincial jurisdiction. In Ontario,this would be under the auspices of the Financial Services Regulatory Authority of Ontario (FSRA).  Ontario based credit unions have a self-funded deposit insurance program. Other provinces would have different arrangements. 

Question: How are deposit brokers and advisors paid? *Are GIC finder’s fees a referral fee or a commission?

Answer: Both! In speaking at great length with one of the early pioneers of the GIC deposit brokerage industry (Ross Dixon) many years ago (sadly, now long gone) he described “agency agreements“ as formal referral arrangements he personally made at each bank or trust company. I believe the first referral arrangement he made was with Morgan Trust in Toronto - in the  late ‘70’s. The founder described mutual fund remuneration as commissions except GIC remuneration were considered to be finder’s fees or referral fees. I believe that things haven’t changed since the 1970’s and banks and other financial institutions still pay finder’s fees or referral fees derived from GIC business to either the adviser’s head office or for smaller firms – directly to the broker. Therefore an advisor can claim that he is earning GIC fees directly or is being paid a GIC commission from his head office. In the regulatory world it is said that there are very important differences between the definition of a commission versus the definition of a referral fee. GICs can have both fees or commissions. Sorry about that - apologies to securities lawyers everywhere!

Question: What is the history of the deposit brokerage business in Canada?

Answer: A thorough search on the internet did not reveal much information about the very early beginnings of the Canadian deposit brokerage industry. I believe that if it was written down, it may have been lost in the sands of time.

Therefore I have cobbled together some of the history that I’ve collected over the years by speaking to one of the early founders and I recall some of the stories from the “old-timer” deposit brokers now long since retired. 

Note: I retired n 2017 so i now qualify as one of the "old-timers"!

In the 1970’s, 80’s and most of the 90’s there was no such term as a GIC dealer or mutual fund dealer - nor did the MFDA (Mutual Fund Dealers Association) even exist. By the late 1970’s there were at least three major deposit brokers. These deposit brokers offered both GICs and mutual funds to their clients and some offered deposit products from insurance companies as well. In the early 1990’s, both client held GICs and mutual funds co-existed on the same investment statement.

I became a GIC broker in 1992 but started my career in 1987 as a stockbroker. Although stockbrokers had mainframe computers back then, I got to see the installation of the very first personal computers - sporting huge 20 meg hard drives and monochrome (choice of green or amber!) screens in 1987 and 1988.

GIC brokers were far smaller operations and there were no mainframe computers or personal computers until the very early 1990’s. We still have our old GIC/mutual fund database going back to circa 1980 or so and they are on recipe cards. 

Yes, you heard right – recipe cards! If a client bought a GIC or a mutual fund, their advisor wrote it down on a recipe card. One card per client. More cards if you were a HNW (High Net Worth) client. The interesting thing about this multi-platform database is that it never required constant upgrading or updates, never crashed and never required any computer power whatsoever. Most importantly, it works just as well today as it did decades ago. The cards do tell me that client name GICs and mutual fund purchases did at one time appear on the same statement and on the same recipe card. If an investor requested a statement, we photocopied the recipe card and gave a copy to the client. \[Note: we now know why many computed mutual fund book values do not accurately reflect investor’s true costs – they were never entered on our head office computers!

Fast forward to the late ‘90’s and our head office at the time, eagerly joined the newly created SRO (Self Regulatory Organization) for mutual fund dealers (MFDA) around 1998. There was a condition though – a big one.

The brand new MFDA (Mutual Fund Dealers Association) made a request (demand?) to the Dealer (our head office)r to divest all client-held GICs (half of the dealer’s total assets). It was determined that GICs are not mutual funds and they would have to go. All GICs from all dealers were to be to be purged from the dealer’s mutual fund statements and computer systems. From now on, the dealer’s mutual fund operation had to be kept separate and distinct from the client name GIC business.

This was a big ask. For deposit brokers this was a huge undertaking and in retrospect, was a big give-up by the industry. But really, deposit brokers had no choice. If they wanted to continue selling mutual funds under the new regulator,, they had to make some big sacrifices. The deposit brokers had to separate out the GICs from the mutual funds and put them on a separate client query and order entry platform. From now on, both GIC's and mutual funds were completely separated and were on  separate computer systems.

Internally,, the dealer’s operation (our head office) was eventually split into two or three separate operations: client name GICs (deposit broker), mutual funds (client name and nominee accounts - mutual fund dealer) and a separate insurance division.

Unfortunately, there as another big give-up and one that I had a personal interest in.

Here's the story. Shortly after becoming a deposit broker, I started a campaign to bring nominee accounts (self-directed accounts just like the ones at my former stock brokerage company to my new firm. Within a year or so, lo and behold - we had nominee accounts!

Nominee accounts were a great success. But alas, 
we had to give up these nominee accounts altogether when we joined the MFDA. Mutual fund dealers or investment dealers (stockbrokers) were the only firms allowed to offer nominee accounts.

> [!info]
> The modern term we use today is “nominee” type of account. In the 1980’s and 1990’s we used the term “self-directed” account to indicate that the securities are held with the broker in a trustee arrangement. The trustee of a nominee account was usually a bank or trust company.

Although there was a predecessor association called the Federation of Canadian Independent Deposit Brokers going as far back at 1985, it is now known as the RDBA (Registered Deposit Brokers Association) which is the national professional standards association for deposit brokers.

***Question: Do I have to pay a commission to buy a GIC?***

***Answer:*** The short and definitive answer is – absolutely not! Investors do not pay commissions to buy GICs because the broker is compensated by the bank issuing the GIC. Part of this compensation is paid to the advisor in the form of a commission or fee. 

***Question: Is it preferable to buy a GIC at a securities dealer?***

***Answer:*** Yes and no. Nominee GIC accounts can only be found at securities dealers or third party trustees but may not have the best interest rates.

Although deposit brokers had at one time, set up nominee (self-directed) GIC structures in-house in the early to mid 1990’s (pre-MFDA), today you would have to be affiliated with a securities dealer to set up a nominee GIC account. So today, all GIC deposit broker GICs are client-held meaning the GICs are held (by the investor) directly at the issuing financial institution. If you want a nominee type of account, you have to buy your GICs through a securities dealer, or a mutual fund dealer but not through deposit brokers. Yes, it is somewhat complicated behind the scenes. Since many deposit brokers are also financial advisors, it is easy to buy a GIC in either format, but you have to take off your deposit broker hat and put on your financial advisor hat to do a nominee GIC purchase with a securities or mutual fund dealer. 

Conversely, if you want to buy a client name GIC, you have to take off your financial adviser hat and put on your deposit broker hat to do the trade.

There are however, issues with credit union GICs in nominee accounts at securities dealers. Due to an interpretation of credit union regulations, most credit union GICs are generally not allowed to be held at a securities dealer which is most unfortunate because credit unions often have much higher interest rates than the large banks. Credit union GICs can however be easily obtained at a deposit broker.

A nominee account is a lot less paperwork intensive than client name GICs. And nominee account structures have other advantages too – especially for estate planning reasons. But on the other hand, there is more choice of financial institutions for client-name GICs. More choice – a much greater chance of consistently obtaining higher interest rates for GIC investors. The choice often comes down to choosing between the conveniences of a nominee account versus the possibility of obtaining better interest rates with deposit brokers.

***Question: Why do deposit brokers and financial advisers offer much higher GIC interest rates than my bank?***

***Answer:*** This is the best keep secret in the entire investment industry. Interestingly, **deposit broker GIC rates and financial advisor GIC interest rates are almost always higher than retail bank GIC interest rates**. In other words, *advisor compensation drives GIC yields higher* for the same identical “no-cost” GIC in a bank branch. For example, a broker GIC rate is almost always quoted higher than the bank in-branch posted retail rates for the **exact same GIC**. Shopping the entire marketplace for the highest yield from all the available issuers would ensure a higher rate is obtained.

A GIC is an unusual type of investment where the existence of a commission or fee can result in a higher rate of return to the investor. Needless to say – never buy your GICs at your own bank without comparing and shopping for better interest rates. Often times, the differences in rates can be mind-boggling! Contact your deposit broker or financial advisor who will show you how to obtain the best GIC interest rates.

***Question: How do deposit brokers offer such dramatically higher rates?***  

***Answer:*** There are a couple of reasons. Banks, trust companies and credit unions are in the deposit taking and lending business. If the bank requires a large inflow of deposits to offset new mortgage obligations they will approach a deposit broker with a higher GIC interest rate in order to attract new deposits. Deposit brokers can move a lot of money to a bank very quickly and efficiently. From the bank’s perspective, deposit brokers are inexpensive sources of capital. The bank doesn’t have to pay costs for brick and mortar operations in order to sell GICs at a deposit broker. It is a highly competitive business. Secondly, a deposit broker deals with dozens of banks – not just one. They can shop for the highest interest rate and obtain a much higher interest rate than the investor can usually obtain on their own.

***Question: How can GICs be used in conjunction with mutual funds or other investments?***  

***Answer:*** GICs should not be considered as a stand-alone investment. They can be used to reduce overall risk in any investment portfolio as GICs do not fluctuate in value and their rate of return is known in advance. You can reduce the risk of owning a stock based mutual fund (equity mutual fund) or individual stocks by investing the GIC interest income into equity mutual funds. In other words, you can reinvest your annual interest income into mutual funds; keeping your GIC principle intact.

For a bit more of a sophisticated way of mitigating equity mutual fund risk, you could buy a 5 yr term compound interest GIC and invest the expected compound interest immediately into mutual funds right now. If the mutual fund outperforms the GIC’s compounded interest rate 5 years from now, you are ahead. Worst case scenario - if the mutual fund drops to zero in 5 years (highly unlikely) at least you get your entire principle back.

Often overlooked too, is that GIC rates have recently handily beat Government of Canada bond yields (1 - 5 years) for the past several years. Bond purchases incur commission costs, driving down their yields even further. GICs have no commissions and yields have been much higher than bonds so GICs can be a superior investment and alternative to short term government bonds.  

***Question: Do GICs have built-in commissions?***

***Answer:*** I think it depends where the GIC is sold. For the banks, some sort of commission element is likely wrapped into the pricing of GICs, especially those GICs that are sold at a bank branch to their customers. However for deposit brokers, GICs don't have built-in commissions.

The argument goes like this; Of course there must be commissions because like most investment products, the deposit broker needs to be paid by charging something.

At first glance, this seems like a reasonable argument. However, GICs are unlike most investments and due to their unique nature they are sold in a different way than most investments. GICs investors are not charged a fee or commission to buy a GIC. It’s the advisor’s head office that earns a referral fee from the bank and then the dealer pays part of that fee to the advisor as a GIC commission. The interest rate on the GIC is set by the bank not by the deposit broker.'s head office. Since neither the dealer nor the advisor sets the interest rate then the remuneration - can’t be built-in.

***Question: Are GICs securities?***

***Answer:*** I first explored this question in the late 1990’s. At the time, some industry participants said yes, some said no. A GIC is merely a bank deposit – not that far off from the concept of a daily interest account – except with a fixed term.

If we ask the same question today - whether or not GICs are considered to be securities, we might get the same answer as we did decades ago – some say yes, some say no.

Why is this question even important? If GIC were to be considered as securities, then securities regulations naturally, would apply but if the regulatory jurisdiction view is that a GIC is not a security, then certain securities regulations do not apply.

Here in Ontario, the provincial securities regulator is the Ontario Securities Commission (OSC). The OSC says that GICs are *not* securities. The national self-regulatory organization for Canadian mutual funds (MFDA) also says GICs are not securities. For the national self-regulatory organization for stockbrokers (IIROC) the definition has been less clear. However, on October 29, 2014, IIROC approved Dealer Member Rule 2800C – Transaction Reporting for Debt Securities (“Rule 2800C”) which clarified GICs status as *non-securities*. However, other provincial securities regulators outside of B.C., Alberta and Ontario, may treat GICs as securities. This question leads into another question; who nationally, regulates GICs?

***Question: In Canada, who regulates GICs?***  

***Answer:*** From a national viewpoint, we are not sure. The sale of GICs is governed by a number of organizations including the federal government under the [DTIR](http://laws.justice.gc.ca/eng/regulations/SOR-2011-98/index.html) (Deposit Type Instruments Regulations). Deposit broker’s professional standards association is the RDBA (Registered Deposit Brokers Association) 

There has been some debate about who precisely regulates the sale of GICs in Canada. I doubt there is any single entity that does. Before I retired in 2017, I came to the conclusion that the sale and regulation of GICs is governed depending where they are sold.

If sold at a bank, then bank regulatory rules apply. If sold at a securities dealer, then securities rules apply. Deposit brokers have their own rules and guidelines to follow as set by the Registered Deposit Brokers Association. The late Finance Minister, Jim Flaherty best described Canada’s securities landscape as a “patchwork quilt” of different regulators. Even today, I think very few would argue the point.

***Question: Are there any other interesting GIC tidbits?  
***

***Answer:*** Here is just a few more to consider...

The Canadian Deposit Insurance Corporation now insures GICs with a term exceeding 5 years where previously - they did not.

Non-redeemable GICs are generally not cashable before their maturity date (there are exceptions; depending on the issuer), and although there are some cashable or redeemable GICs, all GICs are generally cashable or transferable at death.

***Question:  Taking inflation and taxes in consideration, why bother at all with GICs?***

***Answer:*** The demand for GICs is generally inelastic meaning that demand does not change much regardless of the current level of interest rates. A typical GIC buyer is not interested in growth or risk – they are interested in safety, preservation of capital and certainty. Arguments about pursuing capital gains from stocks and bonds and advice to make income more tax efficient or beating inflation will surely fall on deaf ears. There is no other widely held investment option that has such an iron-clad guarantee. Often times, an investor who has cashed in considerable amounts of stock-based investments will crystallize their gains by placing them in GICs.

The same applies to business owners that have sold their family businesses – they’ve dealt with risk all their working lives so the security of GICs can be very appealing to them. Seniors too may be thinking about rebalancing their investments to more conservative GICs. GICs by nature, are floating rate investments which will keep pace with higher interest rates should interest rates rise.

Are GICs as dull as grass? Yes certainly. And we are thankful they are!

Details

Category: Newsletters

Published: 16 January 2017

Hits: 7079

New mutual fund reporting - art or science?

In doing my own research on mutual fund rates of return and even gain/loss calculations, I quickly found it to be a complex subject, even for someone that has a mathematical background.  I consulted with widely respected analyst; Dan Hallett¹, Morningstar Canada editor Rudy Luukko² and Andre Fok Kam³ about some of the big changes regarding investors’ statements and reporting that we will see in 2017.

Mr. Luukko had some reservations about book values on client statements and cautions readers not to use them for their taxable gain/loss calculations. Book values (sometimes referred to as book costs) sometimes do not reflect their proper adjusted cost base used for tax calculations. Dan Hallett also questions the usefulness of book values. He says: “[Book values] may or may not reflect ACB or net amount invested.  But for most, it’s unlikely to be an accurate measure of either.”

Here is another scenario where a book value may not reflect a true gain/loss. Because book values increase with each reinvested distribution, for some fixed income mutual funds that reinvest large distributions on a regular basis, you could theoretically encounter a situation where the book value exceeds the market value. Mathematically, this would show as a loss when in fact, the mutual fund could have a gain.

Why is ACB (Adjusted Cost base) so important? Tax professionals would use ACB to determine capital gain/loss for tax purposes. What about book values? Mr. Luukko says the intent of using book values was to comply with new regulatory requirements (CRM2) as securities dealers are mandated to provide gain/loss information to investors.

Dan Hallett has written an excellent article (with examples) on the new but very different way of calculating a rate of return called dollar or money weighted rate of return. A link is provided at the end of this article. Investors will be seeing these different performance numbers in a brand new Investor Performance Report that will be mailed out in 2017. In his article, Mr. Hallett cautions readers to be careful with these reported performance numbers, noting that calendar date biases may result in numbers that may not be meaningful in certain circumstances or comparing rates of return with other advisors may be difficult.

Securities regulators have decided that money weighted/dollar weighted return is to be used from now on. This formula is also referred to as the IRR (Internal Rate of Return). The return of the mutual fund itself uses a different formula called a time weighted rate of return.

Although the regulators have decided that advisors and their firms must use money weighted rate of return calculations, Mr. Hallett says he would have preferred to see time weighted calculations as did the CFA Institute. “Time weighted would have made so many things much easier – e.g., comparisons with broadly based indices; custom benchmarking; calculation of other performance metrics like Sharpe, alpha, etc.”

While regulators allow the advisor firms to use any method for internal reporting purposes, the money weighted return method must appear on the new Investor Performance Report that investors will be receiving in the mail in 2017. Some Dealers will be giving their advisors the option of adding time-weighted returns to advisor generated rate of return reports so investors can see both money weighted and time weighted rates of returns.

However, investors should be aware of some of the disadvantages of using money weighted (IRR) rate of return calculations. For instance, the formula presumes all cash flows during the time frame measured, are reinvested at the same internal rate of return – an assumption that some believe is completely unrealistic. Although empirically, the IRR is only the number or numbers that makes the Net Present Value of the cash flows = 0 in the IRR equation. If there are multiple rates of return that satisfies the equation, then that’s just the math. Having said that, in speaking with a mathematician - a Ph.D. in Applied Mathematics, there could also be a correlation between cash flow size and the possibility of multiple returns as well. He cautioned about “black box” formulas that do not handle IRR calculations very well and had some cautions about the use of Excel for IRR calculations.

Much of the modern literature seems focused on “fixing the IRR problem” by approximating the IRR formula using other equations. Ironically, the newly mandated use of IRR replaces the previous preferred rate of return model called the Modified Dietz Method which doesn’t have the multiple rate of return problem.

In the paper⁵ from Yuri Shestopaloff, Ph.D. and Wolfgang Marty, Ph.D. (Properties of IRR Equation with Regard to Ambiguity of Calculating of Rate of Return and a Maximum Number of Solutions) the authors appear to prefer the Modified Dietz Method for the calculation of rates of return.

If there are a number of swings of money coming in and going out of a mutual fund account, calculating an IRR rate may result in two or more multiple rates of return⁴. Or even worse –none.  Mathematically speaking, each of these multiple returns are 100% correct and the observer is sometimes left with the difficult task of choosing one over the other. Sometimes it may not be intuitive which one is the “more correct” answer.

[Editor’s note: Although mathematicians can appreciate the beauty of pure math and report there can be more than one correct answer for the same polynomial equation (Descartes Rule), telling investors they could have multiple rates of return for the same mutual fund –all of which are perfectly correct –will make for some engaging discussions.]

Dan Hallett says that many clients have money moving in or out of their accounts and Descartes Rule can be a real issue for them.

Although going forward, calculating money weighted (IRR) rates of return (despite the challenges) could be for the most part, useful, there is a red flag regarding the transfer of mutual funds from one dealer to another. Mr. Hallett is referring to a dealer change when an advisor moves from one dealer to another. This is a very common scenario. In this case, the client’s mutual funds are transferred intact [this is called an in-kind transfer] from the relinquishing dealer to the new dealer at the market price the day the units are received by the new dealer. For the purpose of calculating a money-weighted rate of return (IRR), the original purchase cost(s) of the mutual fund do not move to the new dealer so the transfer-in of securities is posted at market value. If it is counted as a very large new purchase it could skew the IRR and it is debatable whether the rate of return would be meaningful. This will likely affect the “since inception” rate of return if you opened your existing account with an in-kind securities transfer. If the time frame measured excludes the securities transfer, all the other rates of return (except the “since inception” return) i.e. 1 year, 3 yr, 5yr or 10 yr returns should be OK.

Difficulties may also arise if a mutual fund is consolidated or merged with another mutual fund resulting in a large in-kind “purchase”. Again, this has the potential to skew returns. Your advisor is best equipped to discuss or alert you about these special situations.

However, Dan Hallett emphasized if the in-kind transfer is “new money” - say from another firm or another adviser, then it can be used as a basis for rate of return calculations.

Andre Fok Kam on the other hand, has a different viewpoint with respect to in-kind transfers of securities. According to Mr. Kam, an in-kind securities transfer is treated the same way as a new cash purchase of a mutual fund and under the letter of the law, the percentage rate of return generated would be perfectly valid under the new CRM2 securities rules.

Notwithstanding the potential issue of multiple rates of returns, if you never have an in-kind transfer in your account and opened your account with a cash purchase rather than a securities transfer, then all of your returns –including since inception should be OK.

Although convention would hold that the best way to measure performance is to compare original costs with a market value – transaction histories are not transferred when a client changes advisors or advisors changes firms. As a result, original costs are left behind. Although attempts have been made in the past to use book values(which incorporates original costs) for rate of return calculations, book values are incremented up every time you re-invest a distribution (so you aren’t taxed twice) in a taxable account. As a result, some say that book values should not be used for performance rate of return calculations at all.

Confusing? It can be. When you receive your new Investor Performance Report, bring it in to your Financial Advisor so both of you can review and discuss it in more detail.

References:

¹ Dan Hallett is Vice-President & Principal of Oakville, Ontario-based HighView Financial Group. Dan's views and opinions are regularly featured in the media and have appeared in several best-selling personal finance and investment books. He is a regular contributor to the Globe & Mail and many other business publications.

² Rudy Luukko is editor, investment and personal finance, at Morningstar Canada. A former chair and founding member of the Canadian Investment Funds Standards Committee (CIFSC), he has also co-authored courses for the Canadian Securities Institute.

3André Fok Kam, CPA, CA, MBA is a consultant to the securities industry. He has advised regulators, fund managers, advisors and dealers.He has served on the Board of Directors of several fund managers, portfolio advisers and dealers and has served as Investment Director and CCO. He writes extensively for several trade publications.

⁴Descartes Rule: There is an indirect relationship between Descartes rule and the number of sign changes between positive and negative cash flows in or out of a portfolio ( money moving in and money moving out), then mathematically, there is a possibility of multiple rates of returns generated by the money weighted rate of return (IRR) formula. Search term: Descartes Rule of Signs.

⁵ Yuri Shestopaloff, Ph.D.,Wolfgang Marty, Ph.D. Properties of IRR Equation with Regard to Ambiguity of Calculating of Rate of Return and a Maximum Number of Solutions

Dan Hallett: Making sense of your new CRM2 performance report

Rudy Luukko: CRM2 won't solve tax-reporting headaches

--

Details

Category: Newsletters

Published: 26 August 2014

Hits: 42552

What is the difference between a nominee account and a client-name account? 

In a nominee account (sometimes referred to as a self-directed account), the investment dealer or mutual fund dealer holds all of your securities in one account. In a client-name account, your investment resides at a financial institution like a bank or mutual fund company.

Sounds confusing doesn’t it?

I like to use the following as an example to help explain the difference between the two types of accounts:

In my office, I had a candy dish (for my clients) with individually wrapped mints. Think of a nominee account as being the candy dish or container. Think of each mint being an individual investment. You may have many investments (mints) in the container but there is only one container and therefore one account. No matter how many investments (mints) you may have – you still have just the one container. In other words, the investment dealer keeps all the investments in safekeeping in one account/container. We can call the container holding all the various investments a 'nominee account'.

To continue with my candy dish analogy I would start removing several mints from the candy dish and line them up. Pointing at each separate mint, I would say that this first mint is located at ABC Bank and the second mint is located at XYZ Credit Union and so on and so forth...

In a 'client name' account, the individually wrapped mint (investment) does not reside at the investment dealer, or brokerage account. It is outside the candy dish. This type of account resides directly at the financial institution itself. For instance, your bank chequing account is likely to be a client name account because the account physically resides at your bank and is not in a brokerage account with your adviser.

Or put another way; you can buy a GIC directly through your bank or buy it through a stockbroker. If you by it through your bank, the GIC resides at the bank. It is registered in your name (client name) at the bank. If you buy it through a stockbroker, it will likely be registered in the investment firm’s name (nominee name) held in trust for you.

What are the advantages/disadvantages of a client name account?

There are a lot of financial institutions in Canada and theoretically, you could open an account at each bank, trust company or credit union in the country. That gives you the most choice but it is a lot of paperwork and bookkeeping dealing with dozens of financial institutions. However, some firms will do that work for you. Deposit brokers for instance, can handle all the paperwork for you as they have agency agreements with many banks, trust companies and credit unions. They can open up an individual client name account at each bank for you and the account opening and on-going paperwork is the deposit broker's responsibility.

Advantages:
A client name account gives you the maximum choice but also generates the most paperwork. Some clients like the maximum control it affords over their investments. Everything is registered in the client’s name at all times. Costs are generally free for these types of accounts.

Disadvantages:
f the account, applications, transfer documents, etc. all require your original signature for most transactions. If you live across town or are out of town, getting to your adviser to sign lots of forms might be a non-starter for some investors.

Estate workload is heavier. A large client name account holding a dozen investments or more at a dozen different financial institutions means that your Executor will have to settle the estate at each of those financial institutions.

Example of nominee registration versus client name registration:

Nominee account registration:

ABC Investment Firm Ltd
In Trust For: John Smith, Account# 123456
ABC Head Office Operations,
999 Anywhere St.
Toronto, ON M1H 1H1

Client name registration:

John Smith
729 Belmont Ave. W.
Kitchener, ON N2M 1P3

[Note: the above client name registration indicates the client has direct ownership i.e. It is in his name and the address is the clients address.]

What are the advantages/disadvantages of a nominee account?

Advantages: The main advantage is convenience. Nominee accounts are registered as an “In Trust For” account (see above example). You can relay your instructions to a broker who can buy and sell investments based on your verbal instructions or on a digital communication. Signatures are generally not required for most transactions.

For an estate situation, nominee accounts can have a real advantage over client name accounts. Although you may have dozens of investments in a nominee account, you still have just one account (remember the candy dish?). There is only one dish - one container, one account! Therefore, only one set of estate documents needs to be submitted.

Disadvantages: Cost. Typical fees for nominee accounts are $125 or higher per year plus tax. There might be fees for additional plans (LIRA, LIF, etc) and fees for unscheduled withdrawals from registered accounts. However, some nominee accounts holding just GICs may be fee free. If you wish to transfer your nominee account(s) to another firm, transfer-out fees can be quite expensive – generally equivalent to 2 years worth of annual fees. Account fees can vary widely from firm-to-firm, check with your adviser about these and other costs.

What type of account is best - nominee or client name?

That’s a difficult question. If we are talking about GICs and you want the best rates then a client name account will provide the highest rates because in a client name account you have the most choice. If however, you like to save reams of paper and like the convenience of dealing with your investments by phone or email rather than in person, then the nominee account can be more appealing.

Because of the extra paperwork involved, if you have a large RRIF account, LIRA or LIF, a nominee account would be the best choice.

For RRSP’s it’s too close to call. If you use a deposit broker, you have plenty of choice. Account size, the number of GICs and how frequently they turn over are all things to consider. For larger RRSP accounts with frequent amounts of transactions, I would give the nominee RRSP the nod.

For out-of-town clients, that can't get to their advisor's office.you want a nominee account where you can relay investment instructions to your adviser over the phone or by email. Whatever digital communication you choose, it is wise to keep a permanent copy of investment instructions. Email is still the language of business transactions. Although this might change as technology evolves, it is still the equivalent of having a "paper trail".

Details

Category: Newsletters

Published: 30 December 2013

Hits: 13907

A short history of mutual fund fees and commissions

I have been reading a lot of articles regarding financial advisor remuneration regarding the purchase of mutual funds in Canada.

I am amazed that so many senior business editors, heads of various trade groups and investor advocates have managed to make so many errors in their attempts to describe what the fees and commission structures are, how they work and how proposed new regulations might affect investors.

Here is some essential background.

Although mutual funds have been around in Canada for several decades, older investors may recall how mutual funds were sold in the early 1980s. There were no deferred sales charge (DSC) funds, low load funds or the various other permutations found today.

If you wanted to buy a mutual fund, you had to pay a commission called a front-end load. The front-end load could be as high as a 9%. The front-end load commission by its very nature is open, transparent and disclosed. The investor would receive a written confirmation detailing what the commission was (in dollars) what the price of the fund was, the name of the fund, purchase date, etc. Not much has changed today and if you choose to buy a mutual fund with an open, transparent and disclosed commission, you still receive the same confirmation details by mail shortly after the purchase date. In any case, no one has ever argued that front-end loads/commissions are not open, transparent or disclosed.

After the mid-1980s, the fund industry introduced a new way of buying mutual funds that neatly managed to side-step the lofty front-end commissions of the time. The deferred sales charge was born. In this unique arrangement, an investor would pay 0% commission to buy a fund and 0% to sell a fund provided that he agrees to one condition: the investor promises not sell his fund within the first seven years of ownership. This is not to say that selling a fund is impossible but early redemption penalties could be severe (up to 6%) if you sold the fund soon after buying it. But if you kept it for the full seven years, you could sell all or part of your fund at no cost plus don’t forget, you escaped the big front-end commission when you bought it. Soon, the DSC way of purchasing a mutual fund became very popular. At the same time, the fund companies introduced the concept of trailer fees. Trailer fees are a fixed annual compensation to the adviser for managing and servicing the account which provides the adviser annual compensation between 0.5% and 1% depending on the type of fund. The press thought this was wonderful – a win-win situation. The adviser gets paid, the investor escapes all commissions and the annual remuneration to the adviser (the trailer) would effectively kill the potential threat of “churning”. Trailers changed the perception of mutual funds forever as advisers no longer had to make a trade in order to make a commission. From now on, mutual funds would not be traded as frequently as stocks.

By the late 1980s, Canada’s banks bought out most of the big stockbrokerage companies and the banks started creating no-load mutual funds of their own. No-load does not mean free as there is still a profit margin built into these products and there is definitely an exchange of compensation from the fund management company to the retail bank side. However, from strictly the view point of the bank customer – bank mutual funds are “free” and they were now in direct compensation with the independent, commission based adviser.

In a free market environment, competition is good and “free” is one of the most powerful market motivators of all. In the early 1990s the competitive marketplace became even more competitive as other no-load funds entered the fray. For instance, during that decade, one no-load firm, Altamira, became a juggernaut of the no-load world. Altamira ultimately, flamed out and crashed and burned during the “tech wreck” as legions of DIY (do-it-yourself) investors piled into their tech funds and then pulled it all out as the tech sector crashed. Altamira went from riches to rags literally, overnight. [1]

In response to an increasingly competitive environment, advisers had to cut commissions and front-end loads went from the high single digits to zero. With commissions at zero who would want to buy a DSC fund that could have a possible exit fee? As a result, DSC funds have greatly declined in popularity and for new purchases, front-end mutual funds at 0% commission (set by the adviser) is commonplace today. Therefore, those advisers living off 0% commissions and the annual trailer (0.5% to 1.0%) are being assaulted by the “make them bleed” press and also by investor advocates that believe (from the press, I gather) that any commission at all (even low ones) is truly evil incarnate.

Certainly we have a wide disparity of views out there.

Therefore, it with some bemusement that I see the media keeps referring to current adviser compensation as excessive and bloated. The DSC fund that was lauded by the press in the 1980s is now vilified by the same press in 2013.

The press indeed does have the regulator’s ear and the Canadian Securities Administration has decided that commissions in general might be, perhaps, possibly, could be, a problem. After extensive study of the subject, I am still trying to find out what problem they are referring to.

Commissions have declined precipitously, churning has all been eliminated, and mutual funds are the cheapest they have ever been. There is far more regulation now and compliance is at the tightest levels ever. So, exactly what is or where is the problem?

Does this mean the press, regulators and investor advocates are yearning for the good old days of the 1980s and 9% commissions – commissions that indeed were open, transparent and disclosed so long ago?

[1] National Bank bought the remnants of Altamira, successfully turned the company around and incorporated the Altamira name into National Bank’s own mutual funds.

I don’t know about you but speaking for my clients, I am not getting all that nostalgic about the good old days of fixed non-negotiable 9% commissions but maybe the regulators may force us to charge front-end loads once again. Talk about things coming around full circle!

Therefore, I find it difficult to believe that the press, regulators, and investor advocates are targeting the current structure of negotiable commissions (now negotiated down to zero) coupled with a trailer fee.

The old DSC method of buying a mutual fund has had its day but with the trend to 0% front-end commissions, mutual fund purchased the DSC way will eventually go by the wayside.

Personally, I prefer that an asset under management fee/service fee/trailer be built in the price of the product rather than force someone to pay a separate bill.