Commissions, bonuses and kickbacks
No matter what your investment, someone has to get paid

With the run-up in equities markets during 2003 many investors are no doubt thinking about taking some profits and moving them into fixed income vehicles to re-establish optimum debt-equity balances.

Nevertheless many investment advisors are telling clients to stand pat. Most genuinely believe that equities will outperform fixed income instruments this year. But others are no doubt influenced, at least in part, by the fact that advisors earn bigger trailer fees when clients hold equity funds as opposed to bonds.

"There's a potential conflict of interest involved in most investment advisor client relationships," said Gordon Pape, author of Gordon Pape's 2004 Buyer's Guide to Mutual Funds. "That means investors need to know how their advisors are being paid, so they can better judge the quality of the advice that they are getting."

During his work assembling information for the many versions of the guide that have appeared over the years, Pape has had a chance to track mutual funds compensation. But it's not easy.

"There's no uniformity out there in terms of how funds charge management expenses and pay trailer fees," Pape said. "Each company seems to have its own category of funds and rate structures. It's a real dog's breakfast."

The problem for individual investors is that although most know about the front-end or back-end commissions that their advisors earn, few have a good handle on the trailer fees, whose existence is only disclosed in the fine print, if at all.

According to one broker, trailer fees, the commissions that mutual fund companies kick back each year to investment advisors can vary between 0.25 per cent and 1.0 per cent of the money being managed.

But the percentage paid by fixed income funds is far less. And when clients hold bonds directly, outside a fund, there's often no commission at all. Yet the broker, whom we'll call Al, denies that remuneration shapes investment advisors' advice.

"Going for the quick commission is very short term thinking," said Al, who works for one the country's biggest brokerage houses. "The client's needs come first. If he doesn't make money then eventually you'll lose him."

Potential conflicts become even more glaring for salesmen that offer both mutual fund and life insurance products.

According to a spokesperson for Advocis, an association of financial advisors, commissions on term insurance can run as high as 40 per cent of the purchase price of the policy. And with whole life policies the rates are even higher, running to as high as 120 per cent of the first year's premium, when volume bonuses are included. This can put advisors who sell both life insurance and mutual funds in a very uncomfortable position.

If a rep has the choice of making an initial sale to a client who has $2,000 a year to invest, his first year's commission will be as high as $2,400 if he sells a life insurance product. If he sells a term insurance product the commission would be only $800, and it could be as low as a couple of percentage points if he sells a mutual fund.

Another major conflict of interest involves index funds, which many observers without a financial stake in the issue think are a good idea, but which often don't get recommended by advisors, because they pay low, and in some case no trailer fees.

There are indications that Canadian investors are beginning to ask tougher questions of their financial advisors, a trend that dates back tech bubble burst. As a result the Canadian mutual fund industry has been under increasing pressure to reduce their management expenses.

In an effort to remove investment advisor bias toward any particular product, many firms have been pushing fee-based accounts, which combine all management cost into one fee, which is expressed as a percentage of the assets under management.

These fees typically run between 1.5 and 2.0 percent per year of assets under management, for portfolios of between $100,000 and $500,000.

Fee based accounts can hold special mutual units, such as Franklin Templeton's F-units, which have lower MERs since brokerage salesmen don't receive any trailer fees.

However although investment advisors' fees often seem high, the alternative, managing your own money isn't particularly attractive either.

Even assuming an investor had the financial competence, the sheer time involved in covering an average diversified portfolio of between 10 and 20 stocks, can be daunting. Just downloading the quarterly reports, investor filings and listening in on the conference calls can run you 30 hours a week per company, which is between 300 and 600 hours a year for the portfolio. And that doesn't include the accounting, tax calculations and other paperwork.

When you look at it that way, a couple of percentage points a year, doesn't seem like all that much.



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