One fund executive calls it "the fallout from the demographic baby boom." It's the DSC, the deferred sales charge that investors pay when they bail from a mutual fund. The fee and its future has the industry up in arms.
"This is a big issue," said one fund marketer. "It raises the question who is your adviser working for? Is it you or is it the fund company?"
In the 1990s, funds were typically sold "back end" with an up-front commission. Financial planners received a 5-per-cent commission based on assets under management (AUM) from the fund company. The planner received an additional annual trailer or management fee that came out of the management expense ratio. In general, planners pocketed half of 1 per cent of AUM for an equity fund and a quarter of 1 per cent of AUM for a fixed-income fund.
Then the market capsized in 2000 and up-front commissions took a body blow. Investors are now keen on more transparent fee-based compensation. The bulk of funds these days are sold "front end" with no commission but a sweetened trailer for the planner: 1 per cent of AUM for equity funds and half of 1 per cent for fixed income.
In both scenarios, the DSC or "deferred sales charge," the cost to the investor to sell his or her units in the fund, declines over time. By year seven, investors can unload their units without a haircut.
The problem is all those fund sales in the nineties are now coming off the DSC schedule. Fund companies keep the details under lock and key but it is safe to say that every month, there's less incentive for billions of investment dollars to stay put. It's created a mess of competing interests.
"We want to retain assets and they [the advisers] want to move them," said a second fund executive who fears shifty planners will automatically move DSC-free investment dollars to a new DSC fund and kick-start the gravy train all over again.
One option is Brandes Investment Partners & Co.'s solution: Roll the funds automatically into a front-end schedule with a sweetened trailer. But for the bulk of companies, doubling the planner's fee is an expensive proposition. An additional half of 1 per cent on $1-billion in equity funds coming off the DSC schedule is $5-million.
The tinkering to stem the tide has begun. In January, AIC Ltd., a fund manager with big redemptions, introduced a DSC schedule that increases trailer fees to planners over seven years. AGF Ltd. is also reviewing its DSC model.
Is it time for a reality check at CIBC?
October fund sales stats last week showed the bank lagging well behind the Bay Street competition, reporting an ugly $116-million in net redemptions. As RBC Dominion Securities noted in a recent report, CIBC is one of the most aggressive players in the retail savings market, a strategy that may in fact be cannibalizing its fund sales.
Settlement talks between mutual fund companies and the Ontario Securities Commission have degenerated into a multimillion-dollar game of word association.
In September, the OSC alleged four firms -- AGF Management Ltd., AIC Ltd., CI Fund Management Inc. and Investors Group Inc. -- allowed market timing in some of their mutual funds. The fund companies pleaded no contest when trading records clearly detailed rapid in-and-out trading in 1999 through 2003.
Their defence? Blissful ignorance. Each firm claims they had no idea market timing was happening and didn't know it was detrimental to the interests of long-term investors. The legal teams involved are now fighting over the language of the final settlement that will note the evils of market timing while at the same time the funds themselves will admit no wrongdoing.
Watch for a remorseful but not quite confessional, succinctly worded agreement soon. Bay Street analysts estimate the fund companies will return anywhere from $20-million to $60-million each.
Then it's time to break out the calculators for some tough math. In an attempt to squash legal action, the fund companies plan to divide the money up among the likely thousands of unit holders hurt by market timing.
Barclays Global Investors Canada Ltd.'s stealth campaign to shake up the fund industry continues.
In another shot across the bow of active fund managers, Barclays' new closed-end fund tracking 100 income trusts raked in $280-million this month, $80-million more than forecast. In addition, the company wants shareholder approval to change the mandate of its $78-million 10-year bond fund to mirror the Scotia Capital Universe Bond Index.
Low costs and solid returns have made the company's group of 17 exchange-traded funds and closed-end funds popular. Since 1999, the company has pulled in about $9-billion from retail investors, giving traditional mutual fund players a good run for their money in a bear market. More offerings are in the works. Ideas under consideration include a new sector index fund based on the S&P/Toronto Stock Exchange Diversified Metals & Mining index.
"Our growth has been good but we actually see, in some ways, better growth ahead," said Gerry Rocchi, president and chief executive officer of Barclays Global in Toronto. Ironically, he accounts for the popularity of passive index investing to a more pro-active community of financial advisers.
"Advisers are converting more to an aligned method of doing business with their client . . . the more people that do that, the more it will make our product attractive."
© 2007 The Globe and Mail. All rights reserved.
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