Fund Investing

Buying mutual funds through a discount broker? You are probably paying for something you aren't getting: advice.
By Wendy Stein | 19/03/18

The Morningstar database tracks more than 650 Series D mutual funds, which are aimed at self-directed investors who deal with discount brokers or directly with the fund company. Nearly all of them include embedded commissions in their management-expense ratios (MER).

About the Author
Wendy Stein is a product manager at Morningstar Canada. She manages products for investment research, portfolio construction and retirement planning. Before joining Morningstar in 2010, she worked as a product manager in the mutual- fund industry for Invesco and Manulife in Canada and Legg Mason in the UK.

Also known as trailing commissions, these are ongoing payments made by mutual-fund companies to fund dealers and investment brokerages, including discounters, for as long as the investor continues to hold the fund. In full-service distribution channels, they are designed to compensate advisors for providing ongoing advice and service concerning their investments and personal finance.

Since discounters provide no advice and very little service beyond order-taking, trailing commissions payable to them for selling Series D funds are much lower than for the corresponding Series A funds that are designed for commissioned-advice channels.

Series D funds typically pay trailing commissions to discount brokers of 0.25% for equity and balanced funds. The highest rates for Series D trailer commissions is the 0.5% paid by Capital Group to distributors of Capital Group Global Equity - Canada D.

By comparison, trailing commissions on Series A funds in equity and balanced categories are usually 1% a year for the front-end-load option, and 0.5% for the deferred-sales-charge option.

Even a 0.25% trailing commission can add up over time -- RBC Global Balanced Series D returned 4.69% for the 10-year period ended in February versus 5.04% for the Series F version that does not pay a trailing commission -- a difference of $535.73 in total. Over that same period, Capital Group Global Equity Series D returned 9.83% versus 10.51% for the Series F version -- a $1,617.97 shortfall. (Series F funds can be purchased only through fee-based advisors.)

Right now, it's uncertain whether trailer commissions of any amount will continue to be permitted. Canadian securities regulators are currently considering whether to ban these types of fund-company payments to distributors, as Australia and the United Kingdom have done.

Another proposed regulatory alternative, though unlikely to be implemented, would be to require each mutual fund to offer a lower-cost series or class of securities available for purchase by do-it-yourself (DIY) investors, either through discount brokerages as well as directly from the fund company. Though the number of D-series options has been growing, the vast majority of funds in Canada are not available in share classes that pay reduced trailing commissions. Thus, Canadians who want to own these funds must pay the full trailer fee, essentially paying for advice they aren't getting.

"Since DIY investors typically do not seek advice, this series or class would have a lower management fee to reflect that no, or nominal, trailing commissions are paid to advisors," the Canadian Securities Administrators stated in a discussion paper released in January 2017.

The CSA noted that trailing commissions at a reduced rate are not payment for advice, but rather for compensating discounters or direct sellers for their administrative, compliance and technological services.

If you're a DIY investor who isn't willing to wait for a trailing-commission ban, you are not without choices. The most widely available mutual-fund families that are available through some discounters but that pay no trailer commissions are Mawer, Leith Wheeler and Steadyhand.

For a much wider selection of investment funds that pay no trailer commissions, consider exchange-traded funds. With ETFs, you'll have to pay brokerage commissions when you buy or sell them -- making them less appealing if you are looking to set up a monthly savings or withdrawal arrangement. But for larger and less frequent purchases, the costs of these commissions, typically $10 or less, would be much less than the ongoing costs of a 0.25% trailing commission.

You could also look into switching to a discount broker that will rebate trailing commissions to your account -- but tread carefully. For example, Questrade is an example of a discount broker that offers to reimburse trailer commissions, though it does charge administrative fees for this service.

To find out whether a fund pays trailing commissions, and how much, check out the Fund Facts disclosure document. They're available on the mutual-fund company's website, or on www.sedar.com, or ask your broker to send them to you. If you already hold the fund, you should have received the Fund Facts document when you made your first investment.

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