Back in the mid 1980s, the mutual fund industry had a problem. There was a large, and growing, difference in the results seen by larger investors compared to smaller ones. The difference at the time was over 2% in favour of the larger investors. This represented a significant concern to the mutual fund companies. Mutual funds promised to bring the performance of industry professionals to average and small investors. It wasn't happening!. The situation was a potential public relations nightmare!
Fortunately there was a lot of data available. The trend was easy to spot. Larger investors tended to buy an investment and hold it for several years. Smaller investors changed their investments every year to the funds which did well
last year! There seems a certain logic that the managers who did well last year should be the ones who do well this year. However the market cycles through stages where different investing styles work better than others. Over the course of a full market cycle (defined as one full bull and bear market cycle - typically about every 6 to 7 years) the investment style tends not to matter. In the short-term, styles do matter! Investing based on looking in the rearview mirror wasn't working well for the small retail investor.
Problem Identified, but What's the Solution?
MacKenzie Financial recognized that smaller investors were very cost conscious. Larger investors think long term and focus much more on potential returns. Smaller investors think shorter term and focus more on minimizing cost rather than emphasizing anticipated returns.
The solution implemented by MacKenzie Financial at the time was to volunteer to pay the 5% commissions provided to the sales force when they help an investor buy their funds, providing the client stayed invested for a 6 to 7 year period. These commissions were reduced to 3% within the last 10 years. The client's money could be withdrawn earlier, as the funds were
NOT locked-in. However, if money was withdrawn earlier the investor would pay back a portion of the commissions the fund had previously paid to the financial advisor.
The result? The 2% gap closed to less than 0.5%! Obviously, this was a step in the right direction. So why was the Deferred Sales Charge (DSC) option eliminated a few years ago?
At the time DSC was implemented industry rules prevented the banks from owning other financial services providers. In 1987, the rules were changed allowing the banks to become subsidiaries of a larger corporation. Those corporations could then own other financial providers. Canada's largest brokerages and mutual fund companies became subsidiaries of the banks.
Why Industry Consolidation became a Problem
One area of business in which the banks excel is in cost management. To the end of November 2024, CIMA (the fund providers industry association) reported mutual fund and Exchange Traded Funds (ETF) market had net purchases (after redemptions) of $64.5B in Canada. If only 10% of these net sales were DSC, then the cost of commissions to the fund companies would have been $1.92B. This is assumes a conservative average 3% commission paid at the time. The fund companies recover the 3% in less than 3.5 years through reduced retainers paid for client servicing costs. The $1.92B is a significant cost and a profitability improvement target!
Thus began a decades long campaign to convince all Canadians that commission method should not be allowed, even though the clients were getting better long-term results because of independent agents using it. The message? No one wants investments that are "LOCKED IN"!
Personally, I find this message to be extremely ironic! A client wishing to access the accounts funds could take any amount out at any time with only 3 days delay (now 2 days). The only financial products average Canadians can purchase which ARE truly locked in are interest bearing investments available only at banks and credit unions!
Anecdotal evidence from the mutual fund companies not owned by banks suggests that smaller investors are returning to the old days of moving between mutual funds every year or two, chasing last year's winners. This is occurring because it is no longer in the interest of an advisor to educate the client on the advantages of buying and holding investments for the longer term! The inevitable result will be the return of the gap between larger investors and smaller ones.
What do we recommend ?
In my opinion, it is time to reverse the decision to ban DSC funds. It's also time to reverse other bank led changes in the industry. See our articles on the use of the term
Risk versus Volatility and on the marketing of
Portfolio funds at the banks.
For other examples of changes we recommend to CIRO to help Canadian investors check out our
Industry Issues blog posts.
This post was prepared with information freely available to all on the internet. I invite the reader to verify the facts for themselves. The purpose of this site is to educate, and any research that you undertake will help you in the long-term! I'm happy to discuss questions via email.
