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Wealth Professional | 29 Sep 2015, 08:15 AM Agree 0
Investor advocates are now echoing a concern first voiced by embedded commission guys worried clients could be forced over to the fee-based model
  • Ken MacCoy, CHS | 29 Sep 2015, 11:10 AM Agree 0
    Who makes more money than the banks?!

    It doesn't matter whether it is service fees, interest rates, bank mortgages insurance or the forced conversion to fee-based accounts for investors ... the banks are all about profits.

    Regarding do-it-yourself investors, there are several takeaways here:

    (1) Investing can be difficult, possibly inscrutable; (2) Some may be capable, others are not; (3) An experienced advisor can help; (4) It is safer to pay for the results.

    Your retirement may depend on the correct decisions. Hire someone to help with what you do not have the expertise.
  • Wealth Advisor | 30 Sep 2015, 01:33 PM Agree 0
    The hot topic of the day for advisors is whether or not the Canadian Securities Administration will “pull the trigger” someday soon and arbitrarily ban all mutual fund commissions. The impact will be immediate and far-reaching.

    What triggered the CSA to review the fund industry? Evidently, it was a suspicion of skewing of investment recommendations to investment products with higher payouts. Specifically, references were made to a small number of fund companies offering up to 2% trailers – double the normal compensation.

    If such a ban was put in place, imagine a world of no front-end funds, no DSC, and no low load funds. Even no-load funds paying a nominal trailer fee would be banned. All commissions, loads, trailers would be banned and the only other business model remaining - would be fees.

    There is a very interesting psychological aspect to all of this as the popular press seems to vilify all commissions -but higher fees are apparently OK. Incredibly, commissions of any sort are so vilified in the minds of some that high fees are better than low commissions. Logical? Not for anyone that can count! Debates regarding how advisors should be compensated have reached epic flame war proportions in the press.

    So what would be a fair and equitable fee or commission that an advisor should charge or what an investor should pay?

    If we restrict this discussion to equity mutual funds, most advisors would say that receiving 1% per year for managing money is fair and equitable compensation. Large, wealthy investors could expect to pay less on a declining scale and smaller investors might expect to pay a bit more. But 1% is the number we see quoted the most as a starting point.

    In what form should the 1% be and should that amount be regulated? Certainly regulators have regulated pay structures in the past. Should regulators cap mutual fund compensation? From a regulatory perspective, it would create a level playing field as all advisors would receive the same embedded compensation. If all advisors receive the same compensation, then there would not be any economic incentive to skew investment recommendations to any one company.

    A question comes to mind though. Why vilify disclosed and embedded commissions and yet in the same breath, allow a free-for-all, open-end fee structure with no legal upper limits?

    Canadian regulators appear to favour the open-end fee model similar to the U.K or Australia where commissions have been banned and advisors have no choice but to charge fees. Fees will be entirely negotiable.

    Therefore, for an investor, the fees you end up paying, may be entirely dependent on your flea-market bargaining skills.

    In a world without the stability of fixed commissions, asset-based fees can be anywhere between 0% to 2% depending on the size of the account and the investor’s bargaining skill set. The deductibility of fees (a supposed tax benefit) will undoubtedly catch the eye of the CRA who will be swamped by millions of investor tax returns submitting fees that suddenly have become tax deductible.

    Like annual trustee fees of years past, this tax holiday could very well end with the next federal budget.

    Moving from a traditional transactional (commission) model with fixed commissions to one with open ended and likely, higher fees could have the effect of ‘reverse churning”. If you are earning 1% a year(or more) and no longer charging commissions ( commissions are banned) then you are given an economic incentive to basically - do less work. Even the most diligent of advisors could soon succumb to the siren call of earning a bigger paycheck with no additional effort. The effect could be subtle for some or easily dismissed by others, but the possibility of getting paid more for the same amount of work, less work or no work at all, is contrary to the capitalist system we live in or the morals our parents taught us.

    Too much psycho-babble? Too far fetched? Maybe not, as U.S. fiduciaries describe a number of downsides of fee-based advisor compensation. Reverse churning and lawsuits over high fees and little work have already become an issue in the U.S. where fee-based accounts are far more prevalent than in Canada. But the temptation to switch to lower risk investments and earn higher compensation is also another potential conflict of interest. Investors aren’t likely to sue advisors during the next stock market crash if the money is invested in a short-term bond fund. If you are earning fees instead of commissions, why risk the assets under management by investing in volatile stock based mutual funds?

    With fewer compliance issues, higher pay, steady annuitized income, advisors can expand their business not by growth in the accounts but by acquiring additional assets and converting them to lower risk assets.

    Curiously, the focus moves away from investment performance to asset acquisition. In reality, no advisor would be called on the red carpet for missing a client’s retirement goal because there was a lack of equity exposure in the account. The original intent was to end the skewing of investment recommendations yet ironically, it is easier to skew recommendations in a fee-based platform.

    No doubt the appeal of higher fees overall (higher than existing commissions) is alluring. Many advisors have already transitioned their top clients to fee-based accounts to avoid the consequences and business interruptions of a regulatory ban on commissions. Fees are indeed open, transparent and disclosed and so are embedded commissions but fees overall are going higher for the majority of investors.

    Not surprisingly, the HNW (high net worth) investor will reap most of the benefits of fee-based plans ( for mutual fund accounts) as they have the pricing power to lower fees well below 1%.

    A single choice fee-based model is not a panacea. It has its own inherent set of conflicts and does not work very well for smaller investors.

    My recommendation is to keep the current two model system with some minor changes. Create a level playing field for commissions by capping embedded compensation to a maximum - per asset class. Capping commissions would definitely end the possibility of skewing recommendations. DSC redemption fees should have a charge-back to the advisor should an investor redeem within the maturity schedule. Regulators should be looking to regulate the open-ended and some might say, the wild West of fee-based plans.

    Perhaps fees as well of commissions should be regulated -equally.
    RE: Ken's comments above.

    When Canada's leading investor advocate cries foul, advisors and perhaps regulators should pay attention. It is truly ironic that the CSA may indeed ban commissions completely and force all advisors into fee-based plans. My average trailer is about 0.8%. If I am forced to go fee-based, I'll be earning at least 1% on average, a nice automatic 25% pay raise for doing no additional work.

    For accounts that hold only stocks and you are a buy and hold investor that trades infrequently then your costs are going to go from 0% to 1% per year of everything in your account.

    The ironic thing is that the advisor’s pay raise is courtesy of the regulator!

    Advisors have been warning regulators over and over about unintended consequences of forcing advisors to the fee-based model. This is certainly a high profile example of one.

    Many advisors are tired of waiting for the axe to fall from the regulator so they are converting to fee-based now before they are forced to.

    Accounts like Ken and millions? of other accounts will have to make the transition to fee-based; like it or not and advisors will have to take those pay raises -like it or not.

    What are the regulators thinking by banning all traditional, transaction based compensation?

    If anything, Ken's story vilifies fee-based plans. At the risk of sounding like a broken record, fees are not a panacea and are not suitable or appropriate for all investors.

    Now that embedded fees are open, transparent and disclosed under CRM2, they don't sound so bad after all.

    Too bad advisors have absolutely no say in the matter. I can't recall any occasion where a regulator asked me for my input. Which is too bad as we can bring a lot of experience and knowledge to the table.
    And no, industry comments do not count.

    PS. The former advisor should have offered Ken a flat fee rather than a AUM fee which severely punishes a buy and hold stock investor. Or better yet, an option to keep the traditional commission structure. If it was me, and I had to choose between a yearly $1,200 cost or an annual $20,000 cost, I would be voting with my feet as well. Clients in such a scenario will move to online discounters or robo-advisors. Maybe stock certificates will make a comeback.
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