Canadian investors continue to suffer some of the highest mutual fund fees in Canada. It’s not that there aren’t very effective low cost investment fund solutions available. There are plenty covering most asset classes and certainly enough to give any investor a globally diversified low cost portfolio. We figure that for about 20 basis points (one fifth of one per cent) an individual investor could assemble a portfolio of ETFs comprising Canadian, US and International stocks, global fixed income and real estate securities. This compares to most mutual funds available that have a management expense ratio (MER) of somewhere between 2-3% – yes, more than 10 times higher! Yet the vast majority of Canadians are still invested in the more expensive option. So when perfectly good options exist, what prevents people from making the switch? What will it take to bring fees down? Will it continue to be a painful grind or will we hit a tipping point where things start to change rapidly?
Miriam Webster defines a “tipping point” as:
“Tipping point: the critical point in a situation, process, or system beyond which a significant and often unstoppable effect or change takes place”
What “critical point” will that be? Regulatory changes are afoot that should make existing fees and compensation more transparent – will investors open their statements and stare aghast at how much of their returns they are giving up in fees and charges? Will they open their statements at all? There are market players like Vanguard that are introducing new products with radically lower fee structures. Will competition drive fees lower or will the message simply not be spread broadly enough? The reality is that the main distribution channels for investments, like our major banks, have a strong vested interest in keeping fees as high as possible. The largest 6 Canadian banks collectively earned $35 billion dollars in 2015, up 5% from the year before (source: CBC) – hardly feeling the pinch of low interest rates or the woes felt by other industries. It always astounds us how “proud” Canadians are of our strong and profitable banks yet continue to pay, knowingly or unknowingly, some of the highest banking and investment management fees in the world.
At last week’s Vancouver Morningstar event, “Is Alpha Shrinking?”, I asked the panelists Paul Kaplan and Barton Waring (who were excellent by the way) what they believed the tipping would be to bring investment costs down in Canada. They cited the experience in other jurisdictions such as the UK, the Netherlands and Australia where regulators have been trying to improve transparency through better disclosure but also have gone so far as to ban certain selling practices and compensation models. In the US the department of labor is trying to impose a “best interest” standard on advisors giving retirement advice. So far the results in other jurisdictions has been mixed. While some industry players have chosen to exit the industry, good lower cost replacement options have been slower to materialize. So the panel’s answer was effectively that costs have to come down and regulation should be a principle driver using some combination of education, transparency and the elimination of certain sales and compensation practices.
We’re not convinced that regulation alone will be sufficient to introduce a “tipping point” dynamic where unstoppable and significant change starts to happen. Malcom Gladwell in his debut book of the same name describes a tipping point slightly differently:
“The tipping point is that magic moment when an idea, trend, or social behavior crosses a threshold, tips, and spreads like wildfire.”
This suggests something less exogenous than regulation will be key, something more social or intrinsic to the industry. Perhaps the spread of robo-advisors will introduce lower fees to enough people to help us cross this magic threshold. Perhaps it’s a bold move by an existing or new competitor in the space. Perhaps a more consumerist grass roots movement takes hold and drives the industry in a new direction. However the existing industry structure, and particularly the distribution channels, are very entrenched and powerful in Canada. So maybe it will have to be regulation for now but hopefully individual investors will take on the fight themselves soon after and truly move the industry towards a real tipping point and lower costs and fees for Canadians.