Over the next few years, you are likely to hear more about what is referred to as the “client relationship model,” or CRM. CRM is a regulatory requirement introduced by the Canadian Securities Administrators to enhance disclosure, which partially came into effect this year. Further phases over the next three years are intended to enhance the standards financial firms and advisors must meet when dealing with clients. These amended rules provide greater disclosure requirements for advisors and enhance the standards they must meet when assessing the suitability of investments for their clients.
The key objective is increased transparency for investors surrounding the fees they pay, services they receive, potential conflicts of interest and the performance of their accounts
All of these mandatory disclosures will be phased in from 2014 – 2016. Similar CRM mandatory disclosure rules were implemented in Australia and England. The implementation of the changes in those countries resulted in a significant reduction in the number of financial advisors working in the industry once rules required them to be transparent about all the fees charged. I suspect that once the new rules are fully implemented, there will also be a reduction in advisors working in Canada.
To help illustrate how these changes may affect you, let’s look at GICs and mutual funds.
Many people may be aware that when a financial institution receives investments from people, they then lend that money to other people at a higher rate, simply acting as an intermediary for profit. What most people likely do not know is that every time you invest in a GIC, the financial institution makes a spread, or simply put, a profit.
Depending on the rates of the day and the length of the term that profit could be range from 10 to 25 basis points per year invested. The range of the fees could be as low as 0.10 per cent for a one year GIC to 1.25 per cent for a five year GIC. So on a $100,000 GIC for 5 years, your local financial institution might make between $500 (low end) and $1,250 (high end). One percent equals 100 basis points in financial lingo. Low-end is calculated 10 basis points x five years x $100,000. High-end is calculated 25 basis points x five years x $100,000. Starting this coming July, all financial institutions will have to disclose this to everyone.
Let’s move to mutual funds. Take that same $100,000 and assume that you invest it into a balanced mutual fund. There are three potential ways the advisor could get compensated for their advice. They could charge a fee initially, between one and five percent – referred to as Front End (FE).
Front End is sometimes referred to as Initial Service Charge (ISC). Some advisors have adapted a structure similar to banks and don’t charge a Front End fee. Other advisors could do a Deferred Sales Charge Fee (DSC), where the client pays nothing initially but the advisor collects around five per cent immediately, so in this case, $5,000 from the mutual fund company because you are now committed to that fund family for six or seven years.
The fees to redeem the DSC mutual fund in the first couple of years may be approximately five per cent, and declining over a six or seven year period at which point the fund can be sold for no DSC costs.
There is also a variation called Low Load (LL) which is simply a form of DSC. If you see DSC on your statements, you know you are locked in. Then inside, embedded in every mutual fund is an ongoing management fee. As an example, a typical Canadian equity fund may have a 2.5 per cent embedded annual fee that is divided up amongst the advisor every year along with the mutual fund manager and their company. These combined fees are often referred to as the Management Expense Ratio (MER). I have found that the MER is rarely disclosed and, with the new rules, it will have to be.
It is very likely that many investors do not know how their advisor makes money or what fees they really are paying. Knowledgeable and professional investment advisors, just like a good accountant, deserve to charge a reasonable fee for their service. But unlike accountants who send you a bill, investment advisors can currently sell you a product and not tell you what they just made.
More advisors are moving to a fee-based approach which is transparent and, in many cases, tax deductible. There is so much more to come that it may be a good idea to start asking questions now. The next time your banker or your advisor speaks to you about a new investment, consider asking for a complete breakdown of what fees you are paying going in to the investment, what the advisor is getting paid, if any fees apply to sell the investment, and what your fees will be each year thereafter for the advisor to manage your affairs.
Advisors that have always provided complete transparency to their clients will not need to make any changes in the way they communicate with their clients. In fact, they may end up benefiting from the CRM changes.