Hidden advisor fees continue to dog mutual fund performance: Dale Jackson

Canadian cash is shown. (Shutterstock.com)

Investors who purchased TD mutual funds through a discount broker before Sept. 12, 2024, have until Dec. 20 of this year to file a claim to be compensated.

The province of Ontario has approved a $70.25M class action settlement with TD Asset Management relating to allegations trailing commissions were paid to discount brokers for advice, even though the brokers were not permitted to provide investment advice.

The settlement is not an admission of liability or wrongdoing by TD Asset Management but the practice of discount brokers collecting trailing commissions was banned by Canadian securities regulators in June 2022.

Despite the ban, discount brokers are not compelled to offer non-advisor versions of mutual funds. Mutual fund companies are not even compelled to offer a discount version.

How trailing commissions are supposed to work

Trailing commissions are intended to compensate legitimate advisors who recommend mutual funds and provide “ongoing advice”.

Few mutual fund investors even know they are paying a trailing commission because it is baked into the price. Trailing commissions are collected by mutual fund companies through a broader annual fee called the management expense ratio (MER).

Fund holders pay the MER based on the amount they have invested in the fund whether it makes money or not. MERs vary from company to company and according to asset class, but a typical fee on an equity fund often tops 2.5 per cent. Inside that fee a typical trailing commission is one per cent.

While one per cent might seem like a small amount it could add up to tens of thousands of dollars as a portfolio grows over time. That’s tens of thousands of dollars not invested and not compounding over time.

How to spot a trailing commission

The best way to tell if your mutual fund has a trailing commission is by simply looking at the letter that follows the name of the mutual fund in your account.

As a general rule, funds that have a trailing commission will have an A (advisor) at the end, and the version that does not charge a trailing commission will have a D (discount).

If the name of a mutual fund purchased through a discount broker is followed by an A, you are paying for advice you never get. The first step is to find out if your discount broker even offers a D version of your fund. In some cases, they do but they conveniently (for them) failed to provide you with the lower cost version. If your discount broker does not offer a D version go to the mutual fund company website and see if they offer a discount series.

Not all fund companies follow the same lettering code, but the proof is in the difference in MERs. If different versions of the same fund show MERs with a difference of about one per cent it really doesn’t matter what they call it. You want the less expensive version.

The trouble with trailing commissions

Trailing commissions are banned in countries including the United Kingdom and Australia even for mutual funds sold through an advisor.

In addition to being hidden, the concept of having a mutual fund company reward advisors for choosing their mutual funds for a client raises questions about who the advisor is actually serving. Is the advisor recommending a fund each year because it is right for the investor or because it has the best compensation from the mutual fund company?

In some cases, a lower cost exchange traded fund (ETF) or investing directly in the market would be more prudent but many advisors are only licensed to sell mutual funds.

If you invest in mutual funds through an advisor, ask about trailing commissions and if there is a way to avoid them.