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Mutual Fund News

Online broker lets mutual fund investors unhitch from trailers

rcarrick@globeandmail.com

A small, independent online broker is doing something about the mutual fund fee grab being perpetrated on do-it-yourself investors.

Questrade Inc. has announced that clients who buy mutual funds will now receive a rebate of the trailing commissions they pay - probably without even realizing they're doing so.

Trailers, as they're called for short, account for a big chunk of the fees paid by investors to own almost all mutual funds. Their purpose is to compensate investment advisers for the work they do in selling funds and providing continuing client service.

Do-it-yourself investors neither need nor want this kind of service. But with only a few exceptions, they are most assuredly paying for it.

Questrade is the latest exception. Through its new Mutual Fund Maximizer service, clients pay a monthly fee of $29.95 and $9.95 per fund trade in exchange for a rebate of the trailers embedded in the fees charged by their funds.

"We're not providing any advice, we're providing a service," said Questrade president Edward Kholodenko. "So we think it's fair that people get these trailer fees back."

Trailers vary a little from company to company, but the usual practice is to set them at 1 per cent of a client's investment in an equity fund per year, 0.5 per cent for bond funds and 0.25 per cent for money market funds.

The idea of rebating trailers to investors who made their own decisions was first tried by a now-defunct firm called ASL Direct. E*Trade Canada tried to do something similar five years ago by offering its clients F-class funds, which are regular mutual funds with trailers stripped out of their fees. E*Trade had a couple of fund companies lined up to participate, but they backed out at the last minute.

The online brokerage division of Royal Bank of Canada, RBC Direct Investing, was next to do something about trailers being charged to self-directed investors. In May, 2007, the firm introduced a new D-class of funds in the RBC fund family with much-reduced trailers.

"We tried to put up an option that we thought reflected the fact that clients are making their own investment decisions, but are still being serviced by a dealer," said Jonathan Hartman, vice-president of investment products at RBC Asset Management.

RBC's D-class funds require a minimum $10,000 investment. The deal offered by these funds isn't as good as a full trailer rebate, but it's reasonably close. Take the $7.1-billion RBC Canadian Dividend Fund as an example. The management expense ratio for the regular version of this fund is 1.7 per cent, while the D-class version (with the reduced trailer) comes in at 1.16 per cent.

Mr. Hartman said almost $1.4-billion has flowed into RBC's D-Class funds, about 2 per cent of the firm's total $70-billion asset base. That's an underwhelming percentage, but remember that we're talking here about an investing option that requires some real savvy to understand properly.

Questrade figures clients will need at least $36,000 in funds for their quarterly trailer rebates to offset the $29.95 monthly fee. If your quarterly trailer rebate is less than your fees, you pay nothing. To find out what kind of rebate you'd be in line for, check out a calculator on the Questrade website.

The Mutual Fund Maximizer service can be viewed as yet another innovation from small but ambitious Questrade. The firm offers a very low minimum commission of $4.95 for online stock trades and it was a leader in making it possible to hold U.S. dollars in a registered retirement savings plan.

The Fund Maximizer service is notable as well for what it tells us about how the financial industry will play an RRSP season that follows a stunningly bad year for investors. Questrade' is hoping to pick up customers who want to invest for themselves but are skittish about picking their own stocks.

"Many investors have obviously taken a beating in the marketplace," Mr. Kholodenko said. "People may be more interested in diversifying their holdings."

The obvious choice for DIY investors who want instant diversification is a low-cost exchange-traded fund, which is basically a stock that gives you the return of a particular stock or bond index. But mutual funds sold without trailers are a lot more competitive with ETFs than conventional funds.

The problem for individual investors is that brokers make more money selling conventional funds with full trailers, even if they do little or nothing to justify this fee revenue.

"It's lucrative," Mr. Kholodenko said. "They're making a lot of money in many cases without having to do very much."

*****

Park your trailers

The online broker Questrade Inc. has introduced a new program to rebate mutual fund trailer fees to clients. Here's how the program works.

You own

A $50,000 investment in an equity fund that has a trailer of 1 per cent embedded in its management expense ratio.

Questrade's deal

Pay $29.95 per month and get your trailers rebated.

Value of your holdings if your fund reports a 6% one-year return

With trailer rebate$53,500 (you get and extra percentage point of return)
Without trailer rebate$53,000
Benefit$500
Minus monthly fees$359.40
Net benefit$140.60

THE GLOBE AND MAIL

© 2007 The Globe and Mail. All rights reserved.

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