Investors, advisors welcome to the age of transparency

CRM2 has finally arrived. Here’s what it means to fee and performance disclosure

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The age of enlightenment for Canadian investors is upon us. In a matter of months, all will be revealed and it will be a game changer.

I’m referring to the long and arduous trek that comes to an end in 2017 when investment dealers are required to report fees and returns to their clients. I know, it seems pretty basic—telling customers what they’re paying and how they’re doing—but the investment industry has fought the regulators tooth and nail to avoid this moment.

Indeed, it was the Canadian Securities Administrators (CSA), the association of provincial regulators, that provided the leadership on this issue. They’ve come out with a new set of rules called CRM2 (Client Relationship Model – Version 2) and they come into effect today.

Times are a changing

CRM2 requires dealers and investment managers to show clients, at least once a year, what they pay for services, including administrative fees, trading and sales commissions, and advice charges.

The dealers will also need to show investment returns, something that is difficult for investors to calculate on their own due to dividend and interest payments, fund distributions and cash flows in and out of accounts.

Despite plenty of warning, investment dealers are scrambling to meet the deadline. Most firms will comply when they issue their year-end statements in January, although technically they can push it off until next July. For firms that have never reported fees and returns, which is most of them, there’s plenty of systems work to do, as well as training of employees. Believe it or not, there’s a large number of advisors who don’t know how to talk to clients about these two basic elements of investing—fees and returns.

Sticker shock

For clients who have a close and open relationship with their advisor, the enhanced reporting will be a non-event. They’re receiving good service and know what they’re paying for it.

There will be a large number of Canadians, however, who are either unaware of what they’re paying and/or are receiving little or no service. They only hear from their advisor at the RRSP deadline and their inbound calls are returned haphazardly. These investors may suffer from sticker shock—“I pay what? For what?”

The fee reporting will be most enlightening for investors who primarily invest in mutual funds. Most funds have a sales commission buried in the MER (management expense ratio), which goes to the advisor and their firm. The trailer fee, as it’s often referred to, is paid annually and is generally 1% for equity and balanced funds, and something less for fixed income funds. I use the word shock because the CSA conducted a survey a few years ago and discovered that two-thirds of fund holders didn’t know their advisor was receiving a trailer fee.

It’s important to note that CRM2 only requires dealers to report the fees for their service and advise. If you’re invested in ETFs, mutual funds or other types of investment products, you’re also paying a management expense ratio (MER) on top of the reported fees. The combination of the two represents the total cost of investing.

Performance: How have I done?

Mutual funds and ETFs report their performance using ‘time-weighted rates of returns’ (TWRR). This is the industry standard for manager reports, marketing materials and advertisements. It’s the return of the fund before taking into that account the impact of money moving in or out.

The returns you’ll see on your statement go a step further, so as to properly reflect your actual experience. The calculation is called a ‘money-weighted rate of return’ (also referred to as internal rate of return or IRR). The MWRR not only takes into account how your investments are doing, but also factors in the impact of your actions – contributions, withdrawals and other trades. For an account that has no activity during the year, the MWRR and TWRR will be identical. On the other hand, with active accounts there can be big differences due to the timing of transactions.

A real example would be useful here. We have a client who holds only our Founders Fund in her TFSA. The fund had a return of 3.9% last year, but her personalized return (MWRR) was lower. Her statement showed 2.8% because she had doubled the size of her investment in the spring after the fund had earned most of its return (markets were weak in the second half). Half of her money got the full-year return (3.9%), but the other half earned very little during the time it was invested.

One of the reasons investing is so uncomfortable for many people is because there’s a large knowledge gap between themselves and their wealth manager. The advisor is the one with the training and all the information. Because he holds all the cards, it’s hard to ask questions or understand what’s going on with your money. CRM2 is a big step towards narrowing that gap. It will make for some awkward conversations over the next year, but in the long run, advisor relationships will be on a more solid foundation. Get ready to be enlightened.

 

3 comments on “Investors, advisors welcome to the age of transparency

  1. As far as I know majority of Canadians actually don’t know anything about CRM2 and most don’t have a clear idea of how much they pay in annual investment fees. Therefore when clients see all reports required by CRM2 planned to appear in 2017 it’s going to be a huge sticker shock for most of them. But at least this way they will catch up with all the essential information they need to be familiar with.
    Regards,
    Jason from http://movingin.org.uk/

    Reply

  2. This is excellent and long overdue. For years, as a financial advisor and planner, I worked on our systems to provide the Time Weighted Rate of Return for our clients. In addition, I always disclosed annual fees (and had to do it manually because systems were not set up to produce this info). I stopped taking any kind of sales commissions in my first year in practice (front ended everything at 0% in spite of my dealer’s objections) as I didn’t want the incentive to be getting funds from my clients and bonus incentives for placing business with certain fund companies. I wanted myciets o bring more investment assets because of performance – not because I talked a good game.

    I also argued against differential trailing fees for different classes of funds. That provided disincentives for doing the right thing for a client. I explained trailer fees to my clients and knew that if I acted in my clients’ best interests and ensured they were making good money for appropriate risks and if they doubled their investment assets over five years because of performance – my income would double too. My clients appreciated the honesty and full disclosure and liked the fact that if they did well, I did well. And not because they kept bringing me more money and fat sales commissions. They brought me more money because I chose investments that performed well for them and appreciated the fact they were not “locked” into a fund family because of a hidden redemption fee (that paid me up front) or lost part of their initial investment for up front sales fees.

    Finally – you still have to watch this return issue because many advisors simply switch their clients from fund to fund every quarter to erase bad performance from the statement. The client needs to see not only the return for each line on the statement but the total portfolio return that includes all the switching done by the advisor. I had a few clients over time who would proudly show me statements and say how well they were doing – but when we sat down, looked at the timing of the money they put into the portfolio and the effect of all the switches – they had not done nearly as well as their current statement was showing as their rate of return – most were less than half. A few had actually lost money over time. It was a disgrace and one of the reasons I got out of the business. And the banks and investment dealers are the worst at disclosing everything.

    There – had my rant.

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