Canadian Securities Administrators recently made headlines for announcing it would consult with the mutual fund industry to ban embedded commissions.
As it stands currently, investment advisors and other mutual fund salespeople get paid in a not-so-transparent way. Most compensation comes through a trailer fee, which is calculated as a percentage of assets an advisor has under management.
Trailer fees are part of embedded management fees paid by the investor. On average, Canadian mutual funds change approximately 2% of total assets annually in management fees, with between 25% and 50% of the 2% going to the advisor. The rest is pocketed by the company managing the fund.
If the CSA does succeed in getting these embedded fees banned, it means advisors will be stuck asking folks to pay for advice out of pocket. According to one mutual fund representative, such advice could cost an investor anywhere from $100 to $300 per hour.
If embedded commissions are indeed banned, it would incentivize financial advisors to put investors in lower cost products like ETFs and then collect a fee on the side. A big reason why mutual funds continue to be sold is the trailer fees paid to advisors.
Such a move will also make consumers more likely to check out one of Canada’s many roboadvisors, companies that use software to help inexperienced investors build low-cost ETF portfolios. These companies charge a small fee on top of that, with works out to a total management fee of approximately 0.5% of assets.
Even if the fund industry succeeds in keeping embedded commissions, there is enough information on low-fee products out there to do significant damage to the mutual fund business. This is ultimately a good thing for investors.
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