Controversy continues to swirl around the Ontario government’s decision to torpedo a proposed ban on deferred sales charges (DSC) on mutual funds.
A few weeks ago, Ontario Finance Minister Vic Fedeli shocked regulators and investor advocates alike by coming out against the ban. Not surprisingly, some big names in the mutual fund industry have cheered the decision.
Most recently, Primerica Canada CEO John Adams praised it in a Financial Post article. Adams, whose firm employs about 6,800 mutual fund representatives, called the proposed ban “draconian.”
In his article, he makes the time-worn argument that banning DSC will create “an advice gap” because “without this type of compensation, there is far less incentive for an advisor to work with a client of modest means.”
What Adams fails to mention are the many conflicts of interest inherent in the DSC model that hurt investors, including those of modest means. Those conflicts are why just 1% of mutual fund assets in the U.S. and Europe carry DSCs compared to 18% of assets in Canada, worth about $300 billion.
He also doesn’t mention that the proposal to ban DSCs by the country’s securities regulators came after six years of study, consultation and debate.
How do DSC mutual funds work? When you buy one your advisor is paid a hefty 5% upfront commission by the fund company. While you don’t pay an initial fee to buy the fund, if you decide to redeem your investment during the first five to seven years, you pay a “sales charge.” Typically, it starts at 6% of your investment in the first year and declines each year to zero in the fifth to seventh year, depending on the fund.
The industry argues that DSCs allow smaller investors to gain access to financial advice they couldn’t otherwise afford.
But it’s mutual fund representatives and the fund companies who are the real winners. For reps, the DSC charge means a lucrative upfront commission, plus trailer fees during the years an investor holds the fund. For fund companies and reps, the DSC means investors have to stay put or pay a high fee to get out.
As for the argument that DSCs are a way for small investors to get financial advice, investor advocate Ken Kivenko notes on his Canadian Fund Watch site that clients without a large amount to invest have alternatives. These include robo-advisors, credit unions and banks that don’t require “pre-paying for conflicted advice and without being locked in for seven years in an actively-managed mutual fund.”
There are also many alternatives to DSC mutual funds—no-fee and exchange traded funds—that are available to investors.
Kivenko believes the conflicts of interest associated with these funds violate existing rules enforced by the Investment Industry Regulatory Organization of Canada and should be banned on that basis.
Investor advocates are calling on the Ontario government to reconsider its opposition to the DSC ban. I wouldn’t hold my breath waiting for that to happen. But we can keep up the pressure on the mutual fund industry to abandon its conflicted sales practices in favour of more transparent, fair compensation.