Mutual Funds to Give Investors Additional Information

Mutual funds are popular among Canadian investors, but how they work, and how much they cost, is confusing for some investors.

That will soon change. As of Friday July 15, 2016, the third and final phase of Client Relationship Model Two (CRM2) went into effect. Phase 3 gives investment firms one year to comply with uniform reporting standards to clarify how mutual funds have performed over time as well as the total costs investors pay as an actual dollar amount. Currently trailer fees, loads, administrative and marketing fees — and other fees — are typically expressed as a percentage.

In addition to showing charges and other compensation, registered dealers will also have to provide an annual investment performance report that covers deposits into, and withdrawals from, the client’s account, the change in value of the account, and the percentage returns for the previous year; and the previous three, five and ten years.

More Transparency

CRM2 has been going on for nearly a decade and came about as a result of complaints that Canadians pay among the highest investment fees in the developed world. Although mutual fund dealers must comply with the new rules by July 2017, in the majority of cases, investors will begin receiving the reports early in 2017. The earlier start is because most firms are choosing to provide the information on a calendar-year basis.

The new regulations cover a lot of ground, but the focus of the July change involves the portion of mutual fund fees that go to the dealer firm and the broker who is making those recommendations. While it may seem like a free service, advisors are generally compensated through loads when funds are bought and sold, and fees relating to administration and marketing.

They’re also compensated through annual trailer fees lumped into the annual mutual fund fee known as the management expense ratio (MER). An average MER is about 2.5%. Trailer fees vary but they are usually around 1% of the total amount invested.

That percentage sounds small, but consider this: an investor with a $40,000 mutual fund portfolio generally may pay around $400 in trailer fees, while a high net worth individual with a $1 million portfolio can pay as much as $10,000.

Add on loads, other fees, and the rest of the MER and that wealthy individual could pay as much as $30,000 in fees on that million-dollar portfolio. And that’s regardless whether the fund generates a return.

Types of Fees

Loads come in two varieties, back-end loads, or fees you’re charged when you redeem a mutual fund, and front-end loads that are charged up front. A no-load fund simply means that you can buy and redeem the mutual fund units/shares at any time without a commission or sales charge. Trailer fees are what a mutual fund pays to a person who sells a fund to you.

You also may be charged fees if you switch funds, start a registered plan, or open or close an account. You could be charged a short-term trading fee if you sell a fund within a certain period. Short-term trading fees are meant to discourage investors from using mutual funds to make a quick profit by “timing” the market. Market timers move in and out of the market or switch between asset classes based on using predictive methods such as technical indicators or economic data.

Some media coverage has contained factual errors about the timing and content of the CRM2 reporting requirements. As a result, the Investment Funds Institute of Canada published a list of myths and facts about what’s happening. The following is an edited, shortened version of that list:

Myth: CRM2 applies mainly to mutual funds.

Fact: It applies to all securities and all dealers and portfolio managers registered with any Canadian securities commission. The securities commissions are encouraging firms to include non-securities products in client reporting, to the extent possible.

Myth: The report on charges and compensation will tell investors the total cost of their investments.

Fact: CRM2 focuses only on the amount paid either directly or indirectly by an investor to the dealer firm. For mutual funds, it doesn’t include the amount paid to the investment manager. For an understanding of the total cost of a mutual fund, investors can review the fund’s (MER).

Myth: The new report on investment performance will provide benchmarks so that investors can evaluate their personal returns based on a benchmark.

Fact: The report on investment performance won’t provide benchmarks. The report focuses on the individual investor’s personal rate of return (ROR) and this can’t be compared to a benchmark. The personal ROR is based on the investors’ specific deposits into and withdrawals out of their accounts, as well as dividends and interest earned within the accounts and changes in the value of the securities held within them. Because each investor has a different combination of deposits and withdrawals, each could have a different ROR.

Under CRM requirements that went into effect in 2014, however, dealers are required to provide clients with a general explanation of benchmarks. Benchmarks may be a helpful measure to understand how a fund has performed over a specific period of time. However, benchmarks aren’t relevant comparisons to an individual investor’s ROR. This is because the benchmark evaluates the performance of a fund over a time period and doesn’t take into account the timing of an individual investor’s day-to-day deposits or withdrawals.

Investors should compare their ROR to their target rates of return to evaluate whether they’re on track to meet their investment goals.

Myth: When investors receive their first reports on charges and compensation, they’ll be surprised to learn how much their dealers are being paid.

Fact: Investors already receive information about dealer compensation, through information presented in percentage terms in the Fund Facts document and in the simplified prospectus. The only change under CRM2 is that these amounts will be provided in dollars and cents and at the account level, rather than just in percentage terms.

If you already, or plan to, invest in mutual funds, consult with your investment adviser for more help understanding the new reports you’ll be receiving.