Are you a victim of fake transparency?
Most people who have investments will be getting their annual Investment Performance, Fees and Compensation Reports over the next few weeks.
As I mentioned in my last blog, not all costs being charged to your account may be represented.
To understand the issue, let's break down the parties that are involved with the management of your investments.
Potentially there could be as many as three parties involved; an advisor, a dealer and an investment manager.
In case you're unaware of how the investment industry is set up, let's look at the most common situation.
Almost all advisors are associated with a dealer. A dealer may or may not be an investment manager.
When it comes to dealers there are basically two types. One type has in-house investment management and the other does not.
To illustrate, let's look at two different dealers. I have omitted names to remove any bias.
What you probably don't see is more damaging to you financially than what you do see.
Dealer A has both in-house investment management and outsourced investment management. If you invest in a mutual fund that is managed directly by Dealer A they make their money by charging you a fee which is taken from that particular fund. If you invest in a mutual fund that is out-sourced, they make their money by receiving a fee from that other company. In both cases they get paid. One is direct and the other is indirect.
Companies like Dealer B have no in-house investment management. Dealer B makes their money either directly from the client (by charging fees or commissions), or from outside investment firms in the form of trailer commissions (think mutual funds).
The Client Relationship Model (CRM2) requires a dealer to disclose the charges and compensation details for all money received by the dealer firm over the previous year.
What it does not require the dealer to disclose is the amount that was charged by the investment manager if there is one.
Regardless of where you invest your money, all the fees being charged to you may not be fully disclosed.
In the current investment environment, it appears that the biggest culprits are mutual funds and exchange traded funds. In both cases, they have management fees that are not normally fully disclosed under CRM2.
If we closely examine both, you should be able to see what's missing.
Let's suppose your investment advisor recommends that you invest in the Fidelity True North Fund – Series B. The management expense ratio is 2.26 per cent.
Of the 2.26 per cent annually that Fidelity takes from you (it actually comes directly out of the True North Fund which is why you don't see it), they send 1.0 per cent to your advisors dealer.
In turn, the dealer takes a cut (depending on the dealer it can be anywhere from 10 to 75 per cent of that fee) and then pays the balance to your advisor.
So when you look at your Investment Performance, Fees and Compensation Report what are you likely to see?
Well, what you probably don't see (in this example) is more damaging to you financially than what you do see. What you don't see is the 2.26 per cent that Fidelity took from you to manage the account.
CRM2 only requires what your dealer received to be disclosed, which in this case only represents 1.0 per cent of the 2.26 per cent it cost you. That's less than half of the fees that you actually paid. For legislation that is intended to increase transparency, that seems fairly opaque.
If your advisor recommends that you invest in any Exchange Traded Funds (ETFs) they too have MERs although ETF MERs are usually much lower than mutual fund MERs.
Exchange Traded Fund MERs can be as low as 0.03 per cent but in some cases can be higher than 0.8 per cent.
Like your mutual fund investment, the MER being charged on your ETFs by the investment manager are probably not being disclosed.
If you do have investments in mutual funds or ETFs, at the very least you should ask your advisor if the fees are being fully disclosed in your Investment Performance, Fees and Compensation Report. If your advisor says yes, ask them to point out where they are. If they say no, ask them to provide you with a list of funds you own and what the undisclosed MERs are.
Fake transparency is a very real problem in Canada today when it comes to investment products. Don't be a victim.