Morningstar Magazine - June/July 2018 - 36

Dispatches

Are Investors Getting
What They Pay For?
AMERICAS

Canada
Buying mutual funds through a discount broker?
You are probably paying for something you aren't
getting: advice.
Morningstar 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. Also known as trailing commissions
or trailer fees, 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. Mutual funds that pay no trailing commissions
are a rare breed.
In full-service distribution channels, trailing
commissions 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 commissionedadvice channels.
Series D funds typically pay trailing commissions
to discount brokers of 0.25% for equity and
balanced funds. The highest rate for Series D
trailing 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. But even a 0.25%
trailing commission can add up over time.
Right now, it's uncertain whether trailing
commissions of any amount will continue to be
permitted. Canadian securities regulators

Morningstar June/July 2018

are 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 investors, either through
discount brokerages or 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, or CSA, stated
in a discussion paper released in January 2017.
The CSA said 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.
DIY investors who aren't willing to wait for a
trailing-commission ban are not without
choices today. The mutual fund families that are
widely available through some discounters
but that pay no trailing commissions are Mawer,
Leith Wheeler, and Steadyhand. Then, there are
exchange-traded funds. ETFs come with brokerage
commissions, making them less appealing
for investors 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.
Wendy Stein is a product manager with Morningstar Canada.

Multistrategy Hedge
Fund Breaks
New Retail Ground
Mackenzie Investments has received the green
light from securities regulators for Mackenzie MultiStrategy Absolute Return, a prospectus-offered
hedge fund with remarkably relaxed risk constraints.
The fund, managed internally by three Mackenzie
teams, has a minimum investment of as low
as $500 for retail purchase options. It will go on
sale May 23, with the delayed rollout giving
the company more time to educate its distributors
on one of its most complex retail products.
In its May 2 product announcement, Mackenzie
bills itself as the first company to bring to market
for Canadian retail investors a fund that is
based on the Canadian Securities Administrators'
"alternative framework proposal" for retail
funds. As Michael Schnitman, Mackenzie's senior
vice president of product, told Morningstar,
the types of exemptive relief that the company has
been able to obtain are part of proposed regulatory
reforms but not official policy. Regulators
have eased constraints on leveraging, short-selling,
and security-specific risk.
Normally, a mutual fund that is accessible to small
investors has very strict limits and conditions
on how much it can borrow. Not this fund.
Regulators have granted an exemption allowing
the Mackenzie managers to borrow cash totaling
up to 50% of the fund's net asset value.
The fund is also allowed to engage in short-selling
of securities with values totaling up to 50%
of NAV. The normal limit for mutual funds is 20%,
and that's only if the fund manager applies
successfully to the regulators for exemptive relief.
The Mackenzie fund has also received permission
to employ leverage of up to three times
its NAV, for which the calculations are based
on a combination of its short-selling exposure and
its use of derivatives. As for portfolio
concentration, regulators are allowing Mackenzie
to hold up to 20% of the fund's assets in

Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018