More discussion about fees and commissions

Buying a mutual fund 25 or 30 years ago might have cost upwards of an 8% commission. Today, the commission for the same fund is likely to be 0%.

Despite the hysterical press declaring all commissions are inherently evil and must be banned, the truth of the matter is that you can't ban commissions if they've already disappeared on their own.

Advisers have largely eliminated front-end load commissions for purchases of mutual funds. If advisers have voluntarily eliminated the commissions they would normally have charged on fund purchases, how then are advisers to be compensated? And what is considered fair and equitable for both the client and their adviser?

As mentioned in my previous articles about fees, back-end load funds (deferred sales charge funds) are rapidly declining in popularity especially for new accounts as new money is mostly going into 0% commission front-end mutual funds.

An inquiry to one of Canada's largest mutual fund companies (Invesco) indicated that "north of 90% of front-end funds are at 0% commission."

The 1% solution

If the regulator decides to ban all commissions, then mutual fund accounts would have to go to a fee-based account system. The fee amount that I see most often quoted as a starting point is about 1% of assets under management (AUM).

Smaller accounts might pay a lot more than 1%, larger accounts would certainly pay less. In the fee-based system, commissions are eliminated but the client is handed a separate bill they must pay.

It is apparent to me that based on U.S. experience, moving the mutual fund business to strictly a U.S. type of fee-based one is a recipe for disaster. The power and influence of the press is very strong here. The press has the regulator's ear even if there are no current problems, conflict of interest issues or any other imagined headline news story.

Better disclosure is already a fait accompli with the new CRM (Client Relationship Model) that is just coming into affect now, and the phone book-sized mutual fund prospectus has been eliminated and will be replaced by Fund Facts. These improvements and reforms have already been done prior to the release of the CSA discussion paper about improved disclosure and banning commissions. Many industry participants are puzzled as to why the CSA appears to be so anxious to pull the trigger without studying other countries fee-based adviser remuneration systems.

Be careful what you wish for

There has been a lot of debate in the press about which remuneration model is "best". Some say the fee-based system is best and will solve all the perceived problems. Others say that fees should be charged hourly and we should emulate the legal profession and bill clients directly each time we touch a client's account. Yet others say that flat fees or asset-based fees could work too.

If commissions are targeted and eliminated by the Canadian regulators and replaced by negotiable fees, we will be in the wild, wild, West of fee-toting gunslingers. Fees will be all over the map with no indication of what a client is getting for their money. What you end up paying will be entirely dependent on your negotiating skills. If you are someone who does not have the requisite flea market bargaining skills to hammer out a deal, you could very well pay more than you should. Is that fair? Is this a system we truly want? Unfortunately, advisers will have no choice in the matter as they will be forced to follow the new rules - whatever they might be.

For some sense of what might happen in Canada should advisers be forced to charge high fees instead of low commissions, we only have to look at the U.S. model where American advisers have already been using a fee-based model for many years. If you read this article about U.S. fees you should come to the same conclusion as I did - what a horrific mess!

Proposed solution

Although I could be accused of overusing the term, "a solution looking for a problem", I think it best describes the media's play on this story.

Banning commissions entirely would cause far more problems than it would solve. It would raise the barriers of entry to new investors, discourage investing in general and would only be of economic benefit possibly, to the high net worth investor.

[Editor's note: I contacted Dan Ariely, renowned behavioral economist and New York Times bestselling author of "Predictably Irrational". He describes a scenario where the consequences of replacing embedded commissions with fees could be "terrible". See my previous article, Adviser fees - the pain of paying]

My proposed solution is very simple. Keep the embedded fixed rate commission structure for mutual funds. Keep also, the existing fee-based account structures.

Shorten the disclosure document (although this has already been done). The regulators can keep the current system of embedded commissions but they can choose to cap them if they deem this as being necessary. For instance, embedded trailer fees could be capped at a maximum of 1%.

Perhaps existing DSC and low load funds can be transitioned to a new class of mutual funds that have no commissions to buy or sell but have an embedded remuneration (AUM fee) to the adviser of say, 0.5% to 1% per year to the adviser.

Whether you call the 0.5% or 1% a fee or a commission is a matter of semantics however, the regulator and the press seem to prefer fees over commissions.

Therefore, the current asset-based trailer commissions we use now could be relabeled as an embedded fixed AUM (asset under management) fee. Needless to say, relabeling commissions and calling them fees in order to boast that you have eliminated commissions seems pretty silly to me.

The psychology of money

Every time I ask my clients, who have previously purchased all-in-one mutual funds with all costs embedded (as long as they know what they are), they typically recoil in horror when I tell them that there is a possibility that I may be forced to send them a new bill for the same services I had provided in the past.

Clients want and prefer the all-in-one pricing but the regulator and press is telling investors –no, that is not what you want.

Somehow the message is not getting through.

I believe that the current system of commissions and fee-based accounts offers a plethora of choices to meet the needs of every investor. To eliminate all choice and increase overall costs/fees to the client may not be in their best interests.