There was some good news recently for the cause of investor protection when all but one of Canada’s 13 securities regulators announced they’ll ban deferred sales charges (DSC) on mutual fund sales.
The ban was announced by the Canadian Securities Administrators, the umbrella group for provincial regulators. Only the Ontario Securities Commission opted not to go along with it.
When you buy a DSC fund, your advisor is paid a hefty upfront commission of 5% by the fund company, plus an ongoing trailing commission that is usually 1% a year on an equity mutual fund.
While you don’t pay an initial fee to buy the fund, if you redeem your investment during the first five to seven years, you pay a penalty. It typically starts at 6% of your investment in the first year and then declines each year to zero in the fifth to seventh year, depending on the fund.
DSCs and other embedded commissions have long been the target of criticism by investor advocates for the conflicts of interest they create for both mutual fund companies and advisors, leading to biased advice to clients.
According to a 2017 CSA consultation paper, these conflicts can produce several bad outcomes for investors, including biased fund recommendations that lead to unsuitable and overly expensive investments. At the end of 2015, 19% of Canadian fund assets totalling $234 billion were held in DSC options compared to less than 1% of assets in the U.S. and Europe.
“The ban…will eliminate an incentive for dealers to recommend investment products that provide them with an upfront commission from the fund company, instead of recommending other suitable investments that have lower costs and do not have redemption fees,” the CSA said in a press release.
In the same announcement, the CSA said all regulators, including Ontario, will also ban trailing commissions being paid to dealers that execute orders but don’t provide advice (i.e. discount brokers). Both changes will become official this year and then there will be at least a two-year transition period.
In 2018, the new Conservative government in Ontario threw a wrench into an agreement among the provinces to ban DSCs. The OSC said it’s now looking at other options to respond to concerns about DSCs.
However, CSA chair Louis Morisset suggested Ontario would have little choice but to eventually go along with the trend toward banning DSCs. Indeed, a number of large mutual fund companies have already stopped selling DSC funds, including the giant Investors Group.
At PWL, we have been long-time opponents of DSCs and other embedded fund commissions that line the pockets of mutual fund companies and advisors at the expense of the retirement savings of ordinary investors.
We believe in complete transparency when it comes to the fees we charge clients. We also rely on low-cost, passively managed funds to make sure they’re capturing the maximum returns possible.
You can only judge the value you’re getting when you know how much you’re paying.