A report commissioned by Canadian regulators considering overhauling mutual fund fees says there is “conclusive evidence that commission-based compensation creates problems that must be addressed.”
The Brondesbury Group reviewed existing research on mutual fund compensation and concluded that evidence on its impact is conclusive enough to justify an overhaul and the creation of new compensation policies.
Among the conclusions the report drew from the research is that funds that pay commission under-perform.
“Returns are lower than funds that don’t pay commission whether looking at raw, risk-adjusted or after-fee returns,” the paper said.
In addition, mutual fund distribution costs raise expenses and lower investment returns.
The report said there is enough evidence from academic research to conclude that advisers “push investors into riskier funds” and that investors, for their part, “readily make sub-optimal choices” because they can’t easily assess what form of compensation is best for them.
While fee-based compensation is likely a better alternative, the report cautioned that there is not enough evidence to state “with certainty” that it will lead to better long-term outcomes for investors.
Academic research has established that compensation influences the flow of money into mutual funds, and that higher commissions stimulate sales.
“Advisor recommendations are sometimes biased in favour of alternatives that generate more commission for the advisor,” the report said.
The Canadian Securities Administrators, an umbrella group for provincial and territorial regulators, commissioned the Brondesbury report as well as a second piece of research that will collect and review data to examine whether trailing commissions influence mutual fund sales. That study is to be completed this summer.
“The Brondesbury Report, together with the comments received during our stakeholder consultations and the forthcoming research by Professor Cumming, is intended to be among the inputs that will be factored into the CSA’s determination of whether to effect certain policy changes,” said Louis Morisset, chair of the CSA and chief executive of Quebec’s Autorité des marchés financiers.
A spokesman for the Investment Industry Association of Canada said officials need time to go through the 81-page Brondesbury report released Thursday before commenting on its findings.
But analysts at CIBC World Markets said they “believe the results of this study will influence the ultimate decision on whether to ban embedded compensation.”
The key points in the Bondesbury report “are consistent with our thesis that a ban on embedded compensation is the most likely outcome,” wrote analysts Paul Holden and Rob Sedran in a late-afternoon note to clients.
Neil Gross, the executive director of the Canadian Foundation for the Advancement of Investor Rights (FAIR), welcomed the report and said it “corresponds” with what FAIR Canada has been saying for a while.
“When advisers get paid in a way that places the adviser in a conflict of interest, investors suffer,” Gross said. “No amount of disclosure changes that. You have to prohibit the conflict-inducing remuneration system.”
Ed Skwarek, vice-president of regulatory and public affairs at Advocis, feels differently however. He said the report was too narrowly focused on fees and does not address broader issues more important to the financial adviser industry, including his association’s call to raise the bar on professional standards.
“We need to look at this holistically,” he said in a phone interview. “This report didn’t do that.”
Others in the industry, meanwhile, said the report offered few surprises and yet it remains unclear what will transpire from its conclusions.
“There is mounting evidence that something needs to give,” said Mark Yamada, the chief executive at Pur Investing Inc. in Toronto. “But I still think regulators in the country are going to think on matters a little longer before making any changes and are probably going to wait for other global jurisdictions to point a clearer path.”