Could capping mutual fund trailing commissions address conflict of interest concerns?

By Susan Yellin | March 23 2017 07:00AM

Peter Intraligi

The distribution of proprietary products sold through captive distribution is a much bigger problem than embedded commissions when it comes to product suitability and potential conflicts of interest in mutual funds, says the president of Invesco Canada Ltd.

Peter Intraligi told a February Morningstar conference on the value of advice that many of the higher cost trailing commissions on mutual funds stem from firms’ proprietary products because they act as incentives to advisors to recommend the company’s product rather than an outside investment that may be better suited to the client. “That’s where we believe the real issue is,” he said.

Rather than have these different fees, Intraligi suggested the industry and investors would be better served by capping mutual fund trailing commissions. “The status quo is not the solution. The industry does need to change, it does need to evolve. It’s happening all over the world.”

Intraligi suggested a 1% across-the-industry trailer for equity funds and 50 basis points for fixed-income mutual funds. The industry should then pick just one deferred sales commissions option and stick with that, he said.

Compensation structure

“The idea here is that if you have the same compensation structure when it’s embedded in the cost of a mutual fund then you eliminate the potential conflicts that exist of recommending one over another,” he said. Advisors who feel that their value proposition is worth more than the fee offered can switch to fee-based, he said.

Capping trailing commissions combined with the transparency brought about by CRM2 should address issues of investor awareness and consistency because they will see on their statements how much they are paying for their mutual funds, he said.

The prospect of banning embedded commissions in mutual funds has been talked about for some time. In early January, the Canadian Securities Administrators (CSA) released a consultation paper asking for recommendations on the future of investment fund fee structures, including banning embedded commissions in mutual funds.

Potential ban

Conflicts of interest are a major reason behind the potential ban. The CSA suggests investors need a compensation model that empowers them and better aligns all their interests. The regulators proposed alternatives, such as upfront commissions, flat fees, hourly fees and fees based on a percentage of assets under administration.

But the CSA paper comes right out and states that they don’t feel they need to see the results of CRM2 before moving on the embedded commission issue.

While Neil Gross, president of Component Strategies Consulting, said a cap can be a promising idea, he wondered aloud whether standardizing fees will truly get to the heart of reducing conflicts of interest. Gross noted that some of the third-party research that has been done in this area points to embedded commissions as creating problems in the marketplace itself.

Capping fees can also put regulators in the position of determining the price of products, said Andrew Kriegler, president and CEO of the Investment Industry Regulatory Organization of Canada (IIROC).

“There are options to go around that,” said Kriegler. “But there is at least the possibility in that kind of a model that the regulatory cap becomes the de facto price in all circumstances. And I think that’s an unfortunate circumstance for regulators to get into because I don’t think regulators should be determining value. That should be a conversation between market participants.”


In addition to dealing with the prospect of a ban on embedded commissions, advisors are also going to have to live in a world with potential competition from robo-advisors.

But Martin Lavigne, president of National Bank Financial, told the seminar that advisors should embrace technology rather than fight it.

“The technology is going to completely disrupt this industry,” said Lavigne. “[But] for me, robo is not a threat. They’re a tool. They’re a tool for us to deliver better advice down the road.”

Lavigne said robo advisors will change how investors access advice – from the current Monday-through-Friday timeline to 24-7.

Robo platforms add convenience, but are generally restricted to portfolio products involving passive exchange-traded funds (ETFs), unlike advisors who can add value by providing any number of investments, said Intraligi. “The advice channel creates an opportunity to look at active-passive alternative strategies that are hopefully customized for their clients and generate the outcome that they’re looking for. Robos fall short.”

But for some people, ETFs are just fine, no different than investors who find the traditional discount brokerage system adequate, said Kriegler. “That is the kind of evolutionary change we are facing and the pace that it’s beginning to pick up at, it does show some sense of being a revolutionary change.”

Best interest standard

The adoption of a best interest standard will help human advisors differentiate themselves from robo advisors, said Gross. But at the same time, he said we shouldn’t underestimate the potential of robo advisors, noting that robots have been building cars and even performing most of the prostate surgery in the United States.

“If you are willing to submit to robotic intervention in that fashion, why would you think that they wouldn’t be just as attracted to a robotic, holistic financial planner?”

The real differentiator, he said, will be the potential of human advisors to inspire trustworthiness and professionalism.

Noted however, was the issue that not all provinces agree with the need to impose a best interest standard, which would make it difficult to trade products across the country.

The British Columbia Securities Commission believes CSA proposed targeted reforms are enough to strengthen the standards of conduct in the best interests of investors. Securities commissions in Quebec, Alberta, Manitoba and Nova Scotia have said they have strong reservations about introducing a regulatory best interest standard and Ontario and New Brunswick have come out in favour of the standard.

Lavigne said the industry needs a level playing field across Canada and best interest doesn’t really get to the heart of the main issues.

“I think the current regime we are under gives us a huge enough obligation,” said Lavigne. “And I think the debate should be around conflict of interest, not necessarily the fiduciary standard.”