Morningstar report angers Canadian advisors

A report by Morningstar Inc. has sparked an outcry, after the Chicago-based research firm suggested that Canadian financial advisors were directing clients into higher fee mutual funds simply to earn higher trailer fees.

Advisor.ca has received numerous e-mails from advisors on both sides of the issue: those who challenge the report and those who view trailer commissions as a conflict of interest. Others just wanted to shoot the messenger.

One common theme, however, was that the fees charged on mutual funds benefit investors in the end.

“A major reason — in my opinion — for the costs of mutual funds is government regulation,” noted one advisor. “If you read the Morningstar report, you’ll see that there were many positive statements made about Canada. For fund companies to do all those positive things, it costs money.”

While many advisors are unable or unwilling to go on the record for compliance reasons, the industry is not without its defenders.

“I think it’s valid for advisors who are paid by commissions and trailers to emphasize products that pay commissions and trailers,” says Dan Hallett, president of Dan Hallett & Associates. “If that’s the way the industry is set up to compensate advisors, then you can’t fault them for wanting to be paid.”

He acknowledges that a small percentage of “ethically challenged” advisors have steered clients into products simply because they paid the most to the advisor.

“The other side of that is advisors are not going to advise clients to invest in products that pay them little or nothing,” Hallett says. “I’m not sure that it’s reasonable to expect them to do that.”

He points out that in the U.S., MERs appear lower than in Canada because the cost of advice is not necessarily bundled into the fund’s fees.

“The published MERs may not reflect the total cost to investors, everywhere,” he suggests. “It’s probably more inclusive in Canada, because so much of the advisory fees are built in, whereas in other countries, you’re more likely to find additional fees paid out side of the fund.”

Comparing these differing models would be akin to comparing the MERs of an A Class fund unit to an F Class unit.

“What’s the difference between a fund that charges 2% and pays the advisor a commission, and a fund that costs 1%, but then the advisor charges 1% on top of that?” Hallett asks. “The total cost is the same. The difference is not in the magnitude, it’s in the structure and the transparency.”

He points out that some readers of the report tend to pick and choose which parts they believe. Investor advocates are likely to agree wholeheartedly that fees and expenses are too high, but then dismiss the high grades given on transparency and investor protection.

“I think discussing it openly is a good thing. I don’t think there’s anything to be afraid of. Advisors who are good, and know they are good, have no trouble discussing these issues.”

Besides, Hallett says, if cost is the primary criterion for an investor, they are probably already do-it-yourself investors, and have a plethora of low-cost investment options available to them.

“To a certain extent, you could argue that even if we do have the highest average fees, it still does not stop people from structuring a portfolio with very low fees.

(05/13/09)