Securities regulators are eyeing a crackdown on the mutual fund industry's fees – including a possible outright ban on some charges, as they look to shield investors from soaring, and often opaque, costs.
Ongoing charges for mutual funds, called trailer fees, are paid by mutual fund companies to financial firms and advisers who recommend their products to clients.
Regulators argue that many investors are unaware their financial advisers are earning a growing portion of their income from ongoing mutual fund fees – and often, are unaware they are being charged at all. Such fees eat into the returns of mutual funds.
The Canadian Securities Administrators (CSA) – an umbrella group for all provincial securities commissions – said Thursday it is considering a variety of reform options that could including capping the portion of mutual fund assets that could be used to pay trailer fees, or even banning the fees.
The advisers typically receive the fees for as long as their clients hold the mutual funds, and the money is paid out of a fund's assets. It means many investors are unaware of the indirect costs they are bearing when they invest in the funds.
In a research paper issued Thursday, the CSA says the average financial adviser now earns 64 per cent of his compensation from mutual fund trailer fees, up from just 27 per cent in 1996. But because those fees are built into the management expenses of a fund, many investors don't know about the payments.
"An important outcome of this trend is that the majority of retail investors are 'seeing' less and less of the cost of distribution," the CSA said.
The research paper comes as the mutual fund industry grapples with criticism about the size of fees, and the reluctance of some advisers to explain those fees and to offer lower-cost alternatives – often criticized as a conflict of interest.
Bill Rice, chairman of the Alberta Securities Commission, said the CSA has already put new rules in place requiring more disclosure to investors of mutual fund fees at the point of sale.
But there has not been fundamental reform to the way fees are charged. Both Britain and Australia have banned trailer fees in recent years, while U.S. and European legislators are debating mutual fund fee reforms.
"Mutual funds are a key investment in the portfolios of many Canadians," Mr. Rice said 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's discussion paper does not recommend a specific reform option, but instead lays out a range of alternatives, and asks for investor and industry feedback on the issues by April 12.
A spokeswoman for the Investment Funds Institute of Canada, an industry association representing mutual fund companies, said Thursday IFIC could not comment on the proposed reforms until officials study the paper.
"We hope we will be included in the roundtable discussions that will constitute the next phase of the review process," Sara Clodman said.
Stan Buell, president of the Small Investor Protection Association, said Thursday he wants to see far clearer disclosure of fees so investors understand mutual funds are not "free" investments that carry no costs. And he said he supports the CSA reform proposal to create a "fiduciary duty" of care for financial advisers, which means they must put their clients' interests first.
"Most Canadians feel their so-called financial adviser has a fiduciary duty – they don't realize that, no, he doesn't have a fiduciary duty," Mr. Buell said. "He doesn't even have a duty to put their interests first."
The CSA analysis said a typical equity mutual fund charges an annual management fee equal to 2 per cent of the fund's asset value. Trailer fees account for half the cost on average, or 1 per cent of a fund's assets, although the rates vary, depending on the fund.
Although investment advisers are earning more from trailer fees, there has been a slight drop in the overall management expense charged by mutual funds, which means mutual fund companies are using a greater proportion of their management fees to pay trailer fees.
The average management expense ratio for long-term mutual funds has fallen from 2.33 per cent in 2001 to 2.06 per cent in 2011, the CSA report said. The average for all funds, including short-term mutual funds, is 1.93 per cent.
Across all mutual fund classes, the CSA study found mutual fund management fees totalled $13.4-billion in Canada in 2011, with trailer fees accounting for $4.6-billion or 34 per cent of the cost.
The CSA paper said while financial advisers must tell their clients about up-front sales charges for mutual fund purchases, they do not yet have to tell them about trailing commissions they will receive from the funds on an ongoing basis. A reform already under way proposes to require such disclosure, however.
The CSA paper also questions whether trailer fees put mutual fund companies in a conflict of interest because they benefit by raising the fees to attract advisers to their funds, but they are also supposed to act in the best interests of the fund itself.
"This practice could put the mutual fund manufacturer at odds with its statutory duty to act in the best interest of the mutual fund to the extent the mutual fund manufacturer, rather than the fund and its investors, is the primary beneficiary of the fund's asset growth," the research paper argues.