A novel approach

(February 2008) In an attempt to gain (or at least retain) market share, some mutual fund companies have taken to increasing the trailing commissions paid to advisors once DSC schedules near expiration.

The idea is that since MERs are unchanging, why not pay out higher amounts to advisors once the high cost of the up-front commission has been amortized. This is being done, of course, in order to provide incentives for advisors to keep their clients invested in the funds (or fund families) that they recommended five to seven years ago.

Since the mantra of the industry is “the client comes first,” why not look at this situation in reverse. Instead of passing a higher percentage of a fat MER on to advisors, why not keep advisor compensation consistent and simply find a way to pass some savings on to clients? Let’s assume the fund in question has an MER of 2.65% (2.5% + GST) and take a look at both scenarios.

Scenario 1

The trailing commission goes up to 60 bps in year six, 70 bps in year seven, and so on until it reaches 100 bps in year 10 and stays at 100 bps thereafter. The fund’s MER does not change.

Scenario 2

The DSC trailing commission stays unchanged at 50 bps for as long as the client holds the fund, but the client’s MER goes down to 2.55% in year six, 2.45% in year seven and continues downward until it reaches 2.15% in year 10. The MER stays at 2.15% thereafter.

Tell me which scenario you would like if you were a client. It is absolutely no secret that cost is a primary concern regarding mutual funds in Canada. As such, I find it remarkable that the industry keeps on coming up with new ways to increase advisor payout, but is not nearly as inventive in devising ways to cut client cost.

Anyone can look at the two scenarios above and see that the fund company is accepting 10 bps less per year every year for five years under both scenarios. As such, ceteris paribus, the product manufacturer should be indifferent … and if one format is “doable” from an administrative perspective, then surely the other must be doable, too. After all, these are just two sides of the same coin.

In fact, mutual fund companies that purport to be concerned about cost could make a big deal out of this. Imagine the enclosure that might accompany a December 31 year end statement: “Mrs. Jones, this is the sixth year that you’ve been invested in the Client Refund Fund. As such, we are crediting your account $50 for the $50,000 you had invested with us this past year. If your account simply holds its current value, your refund will be $100 this time next year.”

Of course, the necessary hoopla would likely have to come from the fund companies directly. My sense is that most advisors would rather keep more money for themselves rather than pass it on to their valued clients.

For those advisors who bristle at the notion that they would choose an option that would benefit themselves at the expense of their clients, I have a suggestion. In the past, I’ve asked people to write to me when they have a rationale for doing one thing as opposed to another. This time, I’m making the opposite request. Don’t write to me at all. Instead, write to your favourite product suppliers and ask them to put this option on the table. While you’re at it, you may wish to remind them that their real clients are the investors who buy their products; not the advisors who sell them.

This article first appeared in the January 2008 issue of Advisor’s Edge Report.

John J. De Goey is a Senior Financial Advisor with Burgeonvest Securities Limited (BSL) and author of The Professional Financial Advisor II. The views expressed are not necessarily shared by BSL.john.degoey@burgeonvest.com

(02/22/08)