If, like many Canadian investors you hold mutual funds, you might wonder how your advisor chose those particular funds. In general, for any investment, higher performance (or returns) exposes investors to higher risk. Based on this you might assume that your advisor chose the best performing funds that matched your risk tolerance.
If only that were the case…..
In 2015, a study entitled “A Dissection of Mutual Fund Fees, Flows and Performance” was commissioned by the Canadian Securities Administration to assess whether sales fees and commissions paid to advisors influence mutual fund selection.
The study found that funds that pay trailer fees to financial advisers attract higher inflows of cash from investors, even when they perform poorly. It also found that those funds tend to perform worse overall than other funds: “Generally, the greater the trailer fee, the greater the level of net flows that has no relationship to past performance.”
(A trailer fee is an ongoing commission paid by the fund management company to the investment firm that sold you the fund. You can read a full description of various mutual fund fees here>>)
To put it in plain language, the study concludes that advisors tend to choose funds that pay them the highest fees, not those that generate the highest investment returns for their clients. In our view, that represents a clear conflict of interest.
Shouldn’t somebody be doing something about this you might ask? Well, in fact, the Ontario Securities Commission is doing something. Under its Client Relationship Model – Phase 2 (CRM2) it has mandated that mutual fund investors receive an annual report that shows, in dollar terms, how much the investment firm that sold them the funds they hold is being paid. Investors will receive the first of these reports in January 2017.
Read carefully! You will be told the amount that the fund manager paid your investment firm. The firm then pays out 30% to 60% of that amount to your advisor. The portion the advisor receives depends on their sales volume—the more they sell the more they get paid.
Caveat emptor! You will not be told the total amount in fees and commissions that you have paid. In fact, it is likely that your total cost is more than twice the amount shown. In a document entitled “Fees and Mutual Fund Investing: the Facts,” Mackenzie Investments explains that for investors in their Canadian balanced fund, which has a 2.28% MER, it pays out 44% of the fees to the investment firm that sold the fund.
Mutual Fund Fees in Canada
One of the reasons for the ‘stickiness’ of mutual funds may be that investors are not fully aware of how much they are paying in fees and how much investment firms and advisors are receiving in ongoing commissions for simply selling funds to them. Under CRM2, if you owned $100,000 of Mackenzie’s Canadian balanced fund, your January 2017 statement will tell you that Mackenzie paid $1,003.20 to your investment firm in 2016. It will not tell you that the total fees paid by you to Mackenzie Investments were $2,280.
One of the key differences between advisors (brokers and financial planners who sell mutual funds) and portfolio managers is that portfolio managers have always disclosed all costs to their clients by directly invoicing them for their services. We also report investment performance (net of fees)—something advisors have not had to do either.
It is a source of pride for us that we are discretionary investment managers, not brokers. We are independent of any bank or broker and our only source of revenue comes directly from our clients. We do not receive any kind of commissions or trailer fees. Sprung Investment Management is committed to meeting a fiduciary duty. A fiduciary duty or best interest standard (already the norm for accountants, lawyers and some other professionals) is a legal requirement that we must put the client’s interests first. That includes avoiding all conflicts of interest and making the best recommendations for the client even if it means lower compensation.
At Sprung, our investment management approach is based on the value investing principles developed by Ben Graham. Graham explained that “the essence of investment management is the management of risks, not the management of returns.” Learn more here>> The management of risk begins when a new client joins us. Clients meet directly with Michael Sprung and other members of our team. We take the time to get to know our clients in order to understand their investment objectives and risk tolerance.
Based on that understanding, we begin to build a portfolio that includes high quality dividend-paying stocks and fixed-income investments. Whereas mutual funds often hold hundreds of stocks, our client portfolios typically hold between 20 and 30. We believe this is a sweet spot for diversification. If you hold more, gains in any single stock will hardly affect the total value of your portfolio. If you hold fewer, losses in any stock can have a greater effect on your portfolio.
In summary, the benefits of portfolio management include:
- A personal relationship with the person who is actually making investment decisions on your behalf;
- Holding a well-diversified portfolio that properly reflects your risk tolerance and investment objectives;
- Avoiding the conflicts of interest inherent in the broker/fund manager model;
- Transparency—no hidden fees or commissions;
- Lower cost.
One other benefit: unlike the embedded fees charged by mutual funds, portfolio management fees are tax-deductible for non-registered accounts.
What is Successful Investing? Learn more here>>
Download Our Free Special Report – How to Hunt For Value Stocks. Michael Sprung will share with you 5 stocks set for long-term gains here>>
We believe that clients gain from our focus on the long-term fundamentals and not chasing short-term trends. Like to learn more? Please contact us here>>
The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.