Financial advisory fees must be transparent and justifiable

Financial advisory fees must be transparent and justifiable
There was a time when brokerage commissions were regulated. Until 1983, when you called your stock broker to execute a trade, she charged fixed commission rates. It was obvious to clients how much they were paying for financial counsel. Fees or commissions for financial planning services, such as asset allocation advice or retirement income projections, were uncommon.
Then came deregulation of the industry, coupled with tremendous growth in the mutual fund and financial planning industries. These two factors led to today’s complex and murky fee disclosure policies that permeate the industry.

The fact is that most clients don’t know how much they are paying (or that they are paying at all) for investment products and advice, as fee disclosure documents are buried deep in the “simplified prospectus.” Many clients never actually see fees being charged as most products report returns net of fees and fees tend to be buried or wrapped within the products themselves. Stricter regulations concerning these hidden fees and commissions are needed in Canada. We are far behind other countries such as the United Kingdom, United States, and Australia in fee disclosure policy.

Australia’s Financial Planning Association, which has led the way as far as fee disclosure goes, has recently outlined some key points to deal with customer concerns about fees. It ruled that clients must be able to clearly understand the fees they are paying and be able to compare those of different products and advisers. Customers must also be given a clear breakdown of the fees they will be paying, separated by fees paid for advice, and by product. They must also have the option of reducing the total fees paid if they feel they are not given quality advice by their adviser. Lastly, financial advisers can only be paid by clients, not by companies that manufacture financial products.

The Australian government is even going further, as it is developing new rules that would ban commissions and volume-based payments for retail investment products. From now on, Australian advisers will need to articulate clearly to their clients precisely what they do for the money they are paid. Canadian advisers need to move in this direction.

In addition to shoddy disclosure, a 2007 study by Peter Tufano, a professor of financial management at Harvard Business School, found that Canada had the highest mutual fund fees in the world. And things have not really changed since this study was published. A recent study by Morningstar entitled “Global Fund Investor Experience 2011” gave Canada an F grade in the category of “fees and expenses.” In fact, out of 22 countries, only Canada received an F; Italy received the next lowest grade — a D. Do Canadian advisers really do a better job at investment management and financial advisory than other countries, justifying higher fees? I think not. Better disclosure would probably lead to lower fees and commissions in the industry.

We are making some headway though; as of July 8, 2011, every investment fund must have a point-of-sale disclosure document that is separate from the simplified prospectus, outlining important information such as management fees and trading costs. Unfortunately, as of now, its distribution to clients is not mandatory.

Advisers themselves don’t have to wait for the regulators to take the lead. They themselves can choose to work on a fee-based model, where the advisory fee is shown directly on the client statement, as opposed to collecting hidden commissions. In addition, advisers should set more reasonable fee schedules. A note to advisers: 2.4 per cent (the average mutual fund fee in Canada) is too high! 

Canada needs to follow in the footsteps of Australia and the U.K., and move to eliminate hidden commissions from the industry.

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