Mutual fund fees to face regulator's scrutiny

Securities regulators are asking for comment on the contentious issue of mutual fund trailer fees — a kind of continuous commission given to financial advisers that many Canadian investors may not know they pay.

Trailer fees are currently embedded in the management fees that are levied annually by the fund companies. They are paid from fund assets, effectively lowering the net returns that the fund’s investors receive.

The fund company rebates the trailer part of that fee — typically one per cent for an equity fund — to the adviser every year that an investor owns the fund.

The trailer fee was originally intended to compensate the adviser for providing service to the client. But since there is no requirement to provide a certain level of service for that fee, it has become more like a sales commission.

Because trailer fees are embedded in the management expense ratio, fund investors don’t usually know that their adviser gets an ongoing commission.

The Canadian Securities Administrators, which is the group that represents all of the country’s securities commissions, issued a discussion paper Thursday that asks for feedback on possible ways of reforming the compensation arrangement to better protect and inform investors.

"Mutual funds are a key investment in the portfolios of many Canadians, "said CSA chair Bill Rice in a statement. "It is important that we look at Canada's mutual fund fee structure carefully in determining what changes could or should be considered to enhance investor protection and foster confidence in our market."

The CSA paper offers several possible options that include:

Providing separate disclosure of trailer fees.

Capping commissions paid to advisers.

Banning trailer fees altogether.

The paper notes that 64 per cent of the average adviser’s compensation came from trailer fees in 2011, up from 27 per cent in 1996. Trailer fees paid to advisers and their firms totalled $4.6 billion last year, according to estimates from the Ontario Securities Commission.

Several studies have found that Canadian mutual funds have some of the highest fees in the world. But the CSA notes that most fund investors have little or no idea how their adviser gets paid. Currently, advisers are not required to disclose to their clients if they receive trailer fees.

The highest trailer fees are paid when clients purchase equity funds over other funds, although most clients don’t know this.

Some jurisdictions, such as the U.K. and Australia, have banned sales commissions and/or trailer fees because of the potential conflicts of interest imposed by such compensation arrangements.

“The current mutual fund embedded trailing commission structure, which offers a 'one size fits all' approach, seems potentially misaligned with the current practice of providing services tailored to an investor’s personal circumstances, expectations and preferences,” the CSA says.

Comments can be sent to the CSA until April 12, 2013. The feedback will frame the discussion for a roundtable the group plans to hold with investors and industry participants later in the year.