Invesco Canada blog

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Peter Intraligi | March 8, 2017

A simpler approach to the future of fees

Recently, I was at the Morningstar Executive Forums in Toronto and Vancouver, speaking on the future of financial advice. The topic has never been more timely, as the industry faces fintech disruption and the prospect of new regulations that are radically altering the landscape.

The Canadian Securities Administrators (CSA) continues down the path toward banning trailing commissions, and Invesco’s public opposition to such a ban began years ago and is well documented. With a new round of consultation underway, I appreciate the opportunity to lead the charge once again as this conversation continues.

As you may recall, the regulator believes that embedded compensation represents an irreconcilable conflict of interest. The argument put forth by investor advocates is that mutual fund companies compete for advisors’ loyalty by offering higher trailing commissions.

While some fund companies have pursued this route in the past, they were the outliers – relatively small firms seeking to gain scale. This was, without a doubt, to the detriment of their clients.

But the prospect of a ban on trailing commissions has led most of these companies to abandon the practice. The industry is trending toward fee-based advice, making oversized trailing commissions increasingly irrelevant.

At Invesco, we applaud the demise of oversized trailing commissions, and have advocated for a simple regulatory approach that would avoid their return: a mandatory cap on trailing commissions at the current standards of 1% for equity funds and 0.5% for fixed-income funds.

This rate is the de facto industry standard and implementing a cap would affect very few advisors.

The CSA is concurrently seeking to implement a “best interest” standard, mandating that advisors place their clients’ interests ahead of their own.

At Invesco, we strongly believe that the vast majority of advisors already put the best interests of their clients first, so mandating this behaviour through regulation wouldn’t pose a problem.

The final phase of CRM2 is already underway, which will ensure transparency on fees. With this information in hand, clients will be able to decide whether they are receiving value.

By capping trailing commissions at the same time, an investor would be reassured that the advice they received was in their best interest, and not driven by the compensation their advisor received.

In the end, it shouldn’t matter how clients pay their advisors, so long as it’s transparent, agreed upon by both parties and the advice received puts their best interests first.

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21 responses to “A simpler approach to the future of fees

  1. @Tony. I am not sure I understand your observations. If a client buys a fund with a 2% MER and that fee pays a trailer of 1% or if the client pays a fee based advisor 1% up front and the f series fund has an MER of 1%….. in what way is the client in any way disadvantaged? Except that the fee is more transparent. Their fee is neither being paid by “assets or lifestyle”. There is not opportunity cost between the two options. The “net return” is the same.

  2. Great Peter Thanks.So how are thee fees to be paid then? If fee based + HST-it could come from assets or lifestyle. If somebody pays them from lifestyle how is that to their benefit? Especially if it for registered accounts (no deductability). What else can the client do with that money that they pay out? Has anybody thought of the lost opportunity cost of that money that the client no longer has. They only talk about what the portfolio would have grown to without the fees. They forget about the out of pocket money that fee based eats up. There is no free lunch in life. Nothing is free!! People’s financial life has to be taken as a whole not in a Micro fashion. They maybe saving on fee here but losing everywhere else in their world. So how are they better off?

  3. I have been wondering for some time why they would not just simply impose a standard trailer across the board if conflict of interest is truly the concern of the regulator. But since there are few companies that offer a higher trailer anyway and to make it level would be the simples solution, I find myself doubting that it is really their true issue. I understand that most fee based advisors charge the usual 1% anyway which is equivalent to the trailer they would have gotten in most cases but with a fee based model I would also be forced to put clients into self directed accounts so the fee can be charged through the dealer and the client being put in a position of having to pay an additional fee for the self directed account which they did not need before to get the same advice and level of support they previously had without that structure. How is that in their best interests? some of those account model are a few hundred a year and there are costs for periodic redemptions as well as other transactions that don’t currently exist in client held accounts. How is that justifiable for a client especially with a small account? A level playing field on trailers makes the most sense and is the lesser cost to clients but I hear very little discussion on that from the regulators as a reasonable solution. In fact our dealer is trying to impose getting us to put all clients into the self directed model now, I would imagine in anticipation of imbedded trailers being banned. This will of course increase not decrease costs to my clients. If I don’t comply I will be fined a monthly fee. So either I pay or the client pays. That is not a conflict of interest? That said I see what the dealer is getting ready for so I blame the regulator not the dealer for increasing costs .

  4. Well done Peter!!
    this model has so much common sense for the embedded option and would standardize the compensation issue. So easy to communicate and transparent for all to see. it is so good to see rational minds wading in on the compensation fiasco.
    thank you

  5. First I’d like to say thank you to Peter for the skill, time and energy he puts in on behalf of advisors on this issue.
    Secondly, Dave Lord makes a good point regarding the 50 bps fixed income vs 100 bps trailer vs advice issue.
    I would add that capping fixed income at 50 bps and equity at 100 bps still leaves a “battlefield” between “portfolio and balanced-income” solutions where the equity/income ratio ranges from about 20/80 to about 50/50. Certainly portfolios above 50% equity tend to offer the 100 bps trail. A new rule could clarify the embedded trail for this area as well. The F series solutions do tend to eliminate these issues and I also suspect that after a year or two of F-series being the norm we will see some standardization of fee levels. Ethically, I like the fee based approach. I am actively moving my clients to that model, but only where it makes sense for the client.
    Which leads to the third issue: a nominee/self-directed/intermediary account is a prerequisite to an F series plan and someone has to pay the associated Trustee fee. Also, some dealers have instituted minimum dollar levels for the advisory fees in the event the negotiated basis point revenue falls too low. Dealers are certainly entitled to these minimum charges. Fee based accounts have higher costs than client name accounts due to the offloading of significant expenses from the manufacturer to the dealer.
    My perspective/environment suggests a minimum cost to the investor of approximately $500 annually to own a fee based plan (Trustee fee plus advisory fees). This means plans with assets of less than $50,000 will be overcharged with a fee based model compared to the existing embedded fee structure when the plan holds 100% equities. The break-even would be approximately $100,000 in the event the plan contains only fixed income.
    Conclusion: fee based has the potential to severely disadvantage investors with smaller investable assets compared to the existing embedded trail model.
    While I commend regulators for their determination to pursue ethical behavior through rule making, this is a situation where the means will not justify the end for many Canadians. I believe beginning investors, most in need of advice, will be the ones who are most disadvantaged from this particular regulatory endeavour.

  6. If the regulators were really interested in educating the public all they needed to do is make sure all funds are sold with the same DSC schedule, LSC schedule and trailer fees. This would make it much easier to educate the population. They could also make all representatives have minimum standards of education and cut the confusion caused by easy to obtain designations that do not reflect the knowledge needed to truly serve clients best interests. The changes we have seen and continue to see have nothing to do with the public’s best interest.

  7. There is no need to try and reinvent the wheel. Trailer fees are needed to fund the “independent branch networks” of the Mutual Funds Industry, which have for the past decades given the behemoth banks a run for their money. Before the growth of the Mutual Funds Industry, the bank brokers were not only acting as one-man mutual funds managers but doubling up as salesmen for the bank branches.

    Fee based accounts right now are co-existing with the trailer fee system, so we cannot conclude that the mutual fund branch networks can survive without trailer fees. Once trailer fees are totally banned, there is no going back.There would be no level playing field, since the banks could continue to fund their own branch network with embedded higher MER, while the Mutual Fund companies would be forbidden to fund the “independent branches” and would be forced to set up their own retail branches. The net effect is a narrowing of competition, less transparency and fewer choices. How can these consequences be in the best interest of the public?

  8. DSC and trailer fees are Mutual Funds Industry innovations that when utilized wisely and responsibly in the right hands could ultimately serve the client long term best interests. Misplaced regulations could overkill innovations and creativity.
    To simply state that if not for trailer fees the Client returns may possibly be higher may make for easy reading but is not “full disclosure” in the sense that alot of other relevant factors and assumptions are left unsaid.
    For example, it is a truism that if the banks stop raising CEOs pay, it is a possibility that our bank fees might fall. There is much left unsaid: cutting off CEO pay raise has to be widespread and frequent over the years to impact banks overheads and ultimately MIGHT lead to higher bank profitability and then MIGHT lead to the banks being more generous in terms of how they treat their customers. On the other hand there are many possible situations that such a move could have no, little or negative impact. Cutting CEO pay might (or might not) lead to loss of talent which might (or might not) lead to lower profit which might lead to lower fees and charges to the consumers. Furthermore, higher profits may not necessarily mean the bankers would be more appreciative and generous with the consumers – they might believe that they deserve the rewards of their smart labour.

  9. Certainly some standardization in the industry would be welcome. If we assume the trailer fee is to compensate us for our advice, does it really make sense that we receive more compensation for an equity portfolio than an income portfolio? Certainly on the manager side there can be more work involved with an equity portfolio than a simpler government bond portfolio. On the planning side our work is based on the clients needs. If one has an elderly client with estate planning issues that wants a conservative portfolio, why is our advice worth only 0.5% versus 1%?

    The Fee For Service model allows us to set our price (percentage) based on our value, not the equity/income ratio of a client’s portfolio.

    The human behaviour issue does favour the embedded fees the client does not see, especially in a declining market. Certainly once they see the fees we must demonstrate our value. If a small investor cannot see the value in having a planner and is not willing to pay 1% visibly then there is not much we can do. If the consensus is to keep the fee out of the limelight by having it embedded then the suggestion to have it negotiable and the client signs off on it sounds good.

  10. In my opinion this is a less complicated solution. It will be good to challenge this and debate this to determine if anything has been overlooked. If it sits well with all parties why not give it a try?

  11. Investors should always have more choices, not less. The banning of trailing commissions would reduce the choice in how investors wish to compensate their advisors. A cap on trailing commissions, instead of an outright ban, would seem to take away the argument that advisors are in the habit of selecting investments based on the amount of trailing commissions they would receive. A 1% maximum on equity funds would be lower than some advisors charge on fee based accounts and I suspect there are significantly more fees in excess of 1% being generated on fee based accounts than there are from trailing commissions in excess of 1%. I would love to see my suspicion analyzed and reported. If it is true then it proves that banning trailing commissions is not necessarily the solution to advisory fee gouging.

  12. Thank you for your continued efforts in this area of concern …. I hope the right decisions are made for clients and advisors alike….

  13. That makes so much sense – why could regulators not see this a such an easy answer . The advise gap would not be relevant with a cap and all would receive personal service as we have always delivered not matter what size their portfolio !! With recent CRMR all is transparent and with a cap conflict is eliminated – so where is the problem . No one is suggesting Real Estate commission be banned !! It is stated clearly and a client accepts it or goes to a comp free structure with less service – No one is suggesting that personal injury lawyers stop charging their substantial % of a claim ( clearly a commission ) ann only charge a hourly rate – why is our industry singled out ?? Thanks you for this !!

  14. I agree 100% with capping trailer fees and making them “standard” across the industry. This is a very simple elegant solution that works in the best interest of clients, as there would be no room to charge clients more than the standard fee. By comparison, banning trailer fees and forcing clients to negotiate the advisor fee WILL put some clients at risk. The regulators and consumer advocacy groups pushing for this mistakenly believe that the average consumer is well equipped to negotiate these fees and compare offerings from numerous competing advisors. Given the governments own statistics on the low level of financial literacy in Canada this his highly unlikely. It’s also naive to think that consumers want to do this or have the time to do this when a perfectly simple alternative is already in place. Another major problem is that there will be no regulation in place to ensure these separately “negotiated fees” are fair or standardized, as already exists under the embedded compensation model. I recently had the opportunity to express this very solution (capping & standardizing trailer fees) to a very senior staff member of the OSC and was shocked at their response. “If we did that, we would have to police the fund companies to ensure compliance”. To which I replied – isn’t that your job? This ended our conversation. The solution is right in front of the OSC and CSA, but for some reason they just refuse to sway from what appears to be their predetermined path. It’s a sad future for consumers in Canada.

  15. Couldn’t agree more. The problem I have noticed with fee for service is that many advisors are charging significantly higher fees than the embedded fees charged by the fund companies. In the end, the CRM2 method will have two significant effects on the investor. 1. Without a large investable asset base, the investor will be limited in the kind of advisor and advice he will get and 2. the investor will pay much more for this service. In the end, the investor loses and the advisor makes more money. That is wrong on many levels. The answer is disclose and give options that the investor has a say in rather than dictate what they have to accept.

  16. Keep up the good fight. Smaller investors deserve an Advisor too and eliminating trailer fees would mean they wouldn’t have too many advisors take them on and they would be at the mercy of the banks having no fear for the competition they would offer very little value or proper advice.

  17. Unfortunately many industry detractors firmly believe that embedded compensation (fully disclosed) is 100% distribution and has inherent and automatic conflicts of interest merely just because the remuneration is built in.
    These arguments harken back to days when we were agonizing whether or not the GST should be separate and disclosed or built-in to the price of product and disclosed.
    Like the GST debate, arguments of embedded vs. un-embedded have devolved to become emotional arguments with each claiming they are cognitive dissonant (ignoring obvious facts).
    Although advisors have embraced the FE=0% model for the last 15 years or so and quite voluntarily reduced their commissions to zero and are quite happy to earn an average of about 0.80% trail for advice/service. Industry commentators and even the regulators themselves are intransigent. Embedded is evil incarnate and it seems – is responsible for all the world’s woes. Arguments that fee-based accounts in a mandated one-model fee world would increase costs to investors dramatically and relegate beginning investors, average investors, small investors and decummulating seniors to their smartphone apps are falling on deaf ears and regulators calls for ways to mitigate investor damage means that the average investor is in the cross hairs. Certainly, from a regulatory and investor advocacy viewpoint, this should be raising alarms.
    It is highly doubtful that any regulator has the will or desire to set compensation given that there are no caps on existing fee-based plans that advisors have been using for many years. It is also doubtful that regulators will ever dictate or control dealer pay grids. The stampede to fees is indeed the Wild West of advisor remuneration – no caps, open-ended and unregulated.
    It is truly odd that Cummings hysteria regarding extreme outliers like 1.5% trails raised such a ruckus when today’s 1.5% annual fee in a fee-based account would scarcely raise an eyebrow. In this strange alternative universe of perceptions -all logic simply goes out the door.
    From an economic viewpoint, dealers and their advisors have worked out the math. Grudgingly accept a mandated pay raise from the regulator or stick to the current low commission embedded model that may not exist much longer. From a “best interest” perspective, which model would you recommend?
    Hats off to Peter for bringing up the issue and offer a solution.
    Advisors unfortunately, have little or no input to the regulatory process and that is a shame.
    Here is my proposed solution: Keep un-embedded fee-based. Keep embedded – make trailers negotiable.

  18. Thanks Peter for continuing to push forward. I would support a cap as above. I have maintained that in a long bear market 2000 – 2003 or 2007 – 2009 that embedded fees, while fully disclosed periodically, will help clients maintain an appropriate investment structure. The reason is simple human nature in that if someone constantly is seeing investor costs or fees, while their portfolio is declining, they are more likely to “take action” and fix this, by redeeming their portfolio or changing it to address the “problem” to their long-term detriment. Embedded fees help with proper investment behaviour. The studies show us that behaviour is bad enough as it is. I support choice for my clients on how they pay us as their professional advisors.

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