Everything You Wanted to Know About Investment Fees But Were too Afraid to Ask – Part 2
As a continuation of our series on mutual fund fees, please see Part 2 below…
How does an advisor actually get paid?
Essentially, there are three basic ways an advisor is paid – up front commissions, trailing commissions and fee-for-service agreements. The five most common mutual fund commission structures in Canada are Front-End Load (FEL), Deferred Sales Charge (DSC), Low Sales Charge (LSC or LL for Low Load), No Load (NL) and Fee-for-service (F Class funds). Each structure has its own unique characteristics and means for which the advisor receives the dealer/advisor compensation portion of the MER. Or, in the case of the NL or F Class fund, that portion of the MER is omitted.
Here is a breakdown of each commission structure:
Front End Load (FEL)
- Advisor has the option to charge the investor a commission of up to 5% of the total investment being made up front. The amount is agreed to between the advisor and the investor and the commission is taken directly from the invested capital.
- Example: If the advisor charges 3% on a $10,000 investment then $9,700 is what the client has invested after fees and the advisor has made a $300 commission. This is the up front commission and is not part of the MER.
- The advisor will typically receive a trailing commission of 1% per year from equity based mutual funds and 0.5% trailing commission for fixed income funds. These fees are included in the dealer/advisor compensation.
- With front end mutual funds there is no fee or penalty to redeem the investment.
Deferred Sales Charge (DSC)
- Pays the advisor an upfront commission that is typically 5% for virtually all mutual funds in Canada. The upfront commission that the advisor receives does not reduce the amount that is initially invested by the investor.
- Example: If the client invests $10,000, then they will have $10,000 of units purchased and the advisor is paid a $500 commission.
- Due to the fact that the advisor received a commission up front, the trailing commissions are usually half that of the same FEL version of the mutual fund, or 0.5% annually for equity based funds and 0.25% for fixed income funds.
- Both the upfront commission and the trailing commission are part of the dealer/compensation portion of the MER.
- There is Deferred Sales Charge or Redemption Schedule that lasts between 5 – 7 years, which penalizes investors for withdrawing from the funds prior to the end of the schedule. This is typically a point of frustration for clients as the DSC Schedule is not always communicated effectively at time of sale. Thus, when the client looks to redeem their funds in a time of need, they are unexpectedly penalized on the withdrawal.
- Within DSC funds, the fund companies will typically allow 10% of the units to be available to redeem every year. This is commonly referred to as the “10% free units”. Anything above this amount will be subject to the DSC Schedule.
Low Sales Charge or Low Load (LSC or LL)
- Very similar to DSC with a few differences.
- Less upfront commission earned by the advisor (typically between 1% and 3%).
- The trailing commission is usually the same as the DSC version but it will usually increase to the level of the FEL fund after the Redemption Schedule has matured.
- There is far more deviation to the commission structures on the LSC versions of the fund than there is with any purchase method.
- The MER is the same as the DSC fund.
- Shorter Redemption Schedule than DSC (typically lasts for 1.5 to 3 years)
No Load (NL)
- Typically sold directly within banking branches where the banking representative is paid a salary by the bank.
- Works very similar to the FEL structure, however there is no option of charging an up front commission.
- For the most part, the banking representative does not have the latitude to invest client assets outside of what the bank offers. Also, if the client is looking to invest in third party investments, that client will typically be referred to an advisor at the bank brokerage to facilitate the purchase.
- For example, if a client invested with RBC and wanted to purchase a fund outside of the RBC family of funds, their RBC banking representative would typically refer that client to a RBC Dominion Securities advisor.
- In the case of NL funds, the 40% of the MER that is paid to the dealer/advisor is typically reduced and the trailing commission is usually retained by the bank.
Fee-for-service (F Class)
- Completely different than the other four and is actually more of a business model, than a fund structure.
- Works much like no load funds, however the entire 40% that is typically paid to the dealer/advisor is stripped out of the MER. In many cases there may also be a reduction in other administrative costs, as compared to a similar fund in the regular FEL-DSC-LSC version, as there is less administrative work involved in managing F Class funds.
- Under this structure the advisor and client negotiate a fee for the management and services the advisor provides and the client is billed either through their investment account or by invoice from the advisor.
- Most advisors that design their business to manage investments in this format will have a fee schedule in place that clearly defines the fees they charge. This is usually a much more transparent model as the fees are openly discussed and paid, rather than embedded.
- If a regular mutual fund (DSC, FEL or LSC) is compared to an F class fund, with no reduction on the fee that the advisor receives, there is usually a 10%-15% reduction in total fees.
The last thing I would like to point out on fees, and this would apply to all fund structures, is that the reported rates of return on all mutual funds are the NET returns AFTER the MER has been taken from the fund. The only exception to this is F class funds, where the advisor compensation should be subtracted from the fund performance to reflect the true rate of return.
This all leads us to the final question:
What do we do at Foundation Private Wealth Management?
Fundamentally, we believe that the industry will be moving more towards the fee-for-service model in the future due to the added disclosure and transparency that will be required from the regulators. As such, we currently have some clients under the fee-for-service model and we are positioning ourselves to transition the business to that model in the future.
Lastly, you can find our fee schedule as part of our “Investment Management” document by clicking this link:
As always, we welcome any questions you may have on fees. Feel free to post a comment to this blog to further the discussion on fees and do not hesitate to contact us directly if you have any questions concerning your account specifically.
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