The introduction of a ban on embedded commissions in mutual funds could lead to an advice gap that might ultimately hurt the investors whom regulators are trying to help, said Paul Bourque, president and CEO of the Investment Funds Institute, in a speech delivered on Thursday at the Economic Club of Canada in Toronto.
Bourque has concerns about proposals in the Canadian Securities Administrators' recent consultation paper that suggest a ban on embedded commissions, including trailer fees, in mutual funds. The alternative would be direct payment by investors of any commissions or advisory fees to advisors.
Specifically, Bourque sees no evidence that a ban on embedded commissions will improve investor outcomes and continues to advocate that investors be given a choice in terms of how fees are paid. He said the more important issue is disclosure, and although new rules under the second phase of the client relationship model (CRM2) will result in more information being given to investors, the investment industry can still do a better job around the communication of various mutual fund fees.
"To give investors a full picture, the fees that the investor pays to the manager of their mutual funds should be part of the annual report to investors, and IFIC recommends inclusion of this information," Bourque said in a question and answer exchange after his speech.
As 80% of mutual funds are sold with the embedded fee option, and mutual fund assets under management total $1.4 trillion in Canada, the proposal to ban embedded advisor compensation "promises to be one of the most transformational, costly and disruptive regulatory initiatives ever proposed," Bourque said in his speech. Thus, it's vital to examine the costs, benefits, and possible unintended consequences, he added.
"Banning embedded commissions will have long-term negative impacts on the ability of Canadians to plan and save, leaving them with substantially lower levels of assets to fund their retirement," he said in his speech.
Bourque pointed to a study by PricewaterhouseCoopers LLP that estimates that a ban on embedded fees in mutual funds would result in individual Canadian investors accumulating, on average, $240,000 less in retirement savings than they would have with access to advice. He emphasized that this amounts to "almost a quarter of $1 million" and said it will create pressure on the social safety net as the population ages.
"Research shows that investors with advice accumulate as much as 3.9 times more financial assets over the long term than comparable investors who do not have advice," Bourque said.
Several studies have shown investors are less likely to seek advice if they have to pay for it up front, he said. Furthermore, evidence from the U.S. and the U.K. shows that costs to average investors have gone up when fees are no longer embedded, he said.
Human nature is such that a large percentage of retail investors will choose not to pay for advice directly, or they won't be able to afford it if they have small accounts that don't meet the minimum investment thresholds of fee-based advisors, Bourque noted.
"It would be regrettable if there was less access to advice for millions of Canadians," he said, "hampering their ability to save for retirement."
Bourque said he agrees with the CSA that there are compensation-based conflicts of interest in the mutual fund industry, but doesn't see the elimination of embedded commissions — which is only one of 23 payment methods the CSA identifies — as the solution.
Instead, Bourque said that IFIC suggested in its submission to the CSA that regulators consider other measures such as standardized trailer fees to remove the incentive for advisor misbehaviour and service agreements related to trailer fees to show investors what they are receiving in return for fees paid.
"We think we can address the concerns without removing access to advice," he said.
Photo copyright: IFIC