Personal Investor: Canadian regulators fail to protect investors from hidden fees
It’s a sucker-punch in the gut for Canadian retail investors. After six years of vowing to ban hidden trailer fees in mutual funds, Canada’s mish-mash of securities regulators have bowed to the investment industry and allowed the practice to continue. That means advisors will continue to be compensated through what amounts to kickbacks from mutual fund companies, ultimately paid for by investors themselves through annual fees known as the management expense ratio (MER).
Here’s how trailer fees work: MERs are based on a percentage of the amount invested in a mutual fund that goes to the mutual fund company each year. They can be as high as four per cent for insured segregated funds but a typical MER is around 2.5 per cent. That means an investor with a $500,000 portfolio of mutual funds pays the fund company $12,500 each year whether the fund makes money or loses money. A portion of the MER – normally one per cent – goes back to the advisory firm or discount broker that originally sold the fund in the form of a trailing commission. That means that same investor with a $500,000 portfolio of mutual funds pays the advisory firm or discount broker $5,000 each year without their knowledge.
Mutual fund companies ultimately determine the trailer fee, which calls into question whether the advisor is choosing funds that are best for the investor, or funds with the most generous trailer fees.
The Ontario Securities Commission itself has cited research that finds the funds that pay higher trailing commissions generate more money from clients regardless of how they perform.
Countries including the United Kingdom and Australia have already banned embedded fees on mutual funds.
One bright spot coming out of the review is a vow to ban embedded fees on mutual funds sold without associated advice. Presumably that means discount brokerages must return the trailer fee to investors. It also bans deferred sales charges or back end loads when a fund is sold – but they have always been negotiable.