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Mutual Fund News

If your adviser urges bank funds, find out why

The big banks are out to dominate the mutual fund business like never before and some of them are using tactics that should cause investors to beware.

It's not enough any more for the banks to sell their in-house funds through branches and related full-service and discount brokerage firms. Today, the banks are trying to get investment advisers to sell their products, too.

Now, how do you suppose a bank might get the attention of advisers who already have access to gazillions of fund choices in every category? One way would be to offer some outstanding funds, something the banks certainly do in some cases.

Another way would be to grease advisers with extra cash so they choose bank funds for clients instead of competing products. Unfortunately, this is also something the banks do in a few cases.

Investors are potential losers here, no matter how you analyze the banks' sales tactics. Self-interested advisers may succumb to the superior level of compensation offered by some bank funds and use them instead of more suitable funds from other companies. Even if a bank fund is a defensible choice, the embedded costs of paying extra compensation to advisers can be a drag on performance.

The way in which some banks sway advisers is virtually invisible to investors. It's all done through trailing commissions, which are paid quarterly by fund companies to advisers as compensation for continuing service to clients. Advisers share the fees with their firms.

A typical Canadian equity fund pays a trailing commission equal to 1 per cent of a client's holding in a fund. Bank funds can be far more lucrative.

Check out the family of funds run by CIBC Securities, which is part of Canadian Imperial Bank of Commerce. CIBC's fund prospectus says that its equity funds pay trailing commissions of up to 1.5 per cent a year. RBC Asset Management pays up to 1.15 per cent in trailing commissions, Scotia Securities pays up to 1.25 per cent in a few cases and both BMO Mutual Funds and TD Asset Management top out at 1 per cent.

What's the harm if a bank fund family wants to lay a little extra cash on advisers? To start with, questions immediately arise about whose interests are being served if a bank fund with a higher-than-normal trailing commission ends up in a client portfolio.

Note as well that turbocharged trailing commissions can have a negative impact on returns. The background here is that trailers are a major component of the costs of owning a fund, almost all of which are lumped together in the fund's management expense ratio or MER. High trailing commissions inflate a fund's MER, and that in turn cuts into the returns that investors make in a fund.

The CIBC Dividend Fund's MER is 2 per cent, which compares with 1.76 per cent for BMO Dividend. Guess what: BMO Dividend outperformed CIBC Dividend 17.06 per cent to 16.79 per cent on an annualized basis over the past three years, a gap that is almost the same as the MER differential.

Something else for investors to watch out for is that RBC and TD Asset Management have a special "adviser" series of their existing funds. Trailing commissions appear to be the same for adviser and regular funds in these two families, but overall fund MERs may in some cases be higher for the adviser funds.

An example is TD Dividend Income -- the adviser series of this fund has an MER of 2.12 per cent while the regular version (called the investor series) has an MER of 2 per cent.

Bank funds, particularly those in the dividend and income categories, have made some serious money for investors over the years. So don't for a moment think bank funds have no place in your portfolio if you have an adviser who can choose from a universe of fund products.

That said, you and your adviser need to have a little chat about any bank funds that crop up in his or her recommendations. The questions to ask are:

How do the trailers you receive from a bank fund differ from comparable funds offered by other firms?

How does a bank fund's overall MER -- remember, this includes the trailer -- compare with other funds?

What does a bank fund offer that can't be found elsewhere?

Remember, it's your adviser's duty to pick the funds that work best for you, not the ones that the banks are pushing.

© 2007 The Globe and Mail. All rights reserved.

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