While some clients like the familiarity of commission-based practices, others are demanding the transparency inherent in a fee-based or fee-only practice.
We spoke with three advisors based across Canada with commission-based, fee-based, and fee-only practices to find out what attracts clients to each model. We conducted this roundtable virtually, with each advisor responding from the comfort of his office.
Which compensation model do you favour and why?
KEVIN REGAN: I favour a commission-based model. It has a number of features that align the interests of the consumer with the advisor. But even within Investors Group, we have a few advisors who utilize a fee-for-service component. The conversation I have with people isn’t ever one or the other. There’s a place for each of the [models] when you start with a client-centric view. At our organization, we focus on the commission basis. And we find it works well for advisors and our clients.
DOUG MACDONALD: I favour the fee-only model, as articulated by the National Association of Personal Financial Advisors. A fee-only financial advisor is compensated solely by the client with neither the advisor nor any related party receiving compensation that is contingent on the purchase or sale of a financial product. [We offer] independent, comprehensive, personal financial advice on a fee-for-service basis. The compensation and its payment are totally within the control of the client. Often, fee-based and commission-based are the same, the dividing line being the percentage-of-asset-based fee is controlled by the client, [while] trailers or wrap accounts—both product-based—are not considered fees. Unfortunately, the term “fee-based” has been used to suggest the consumer is getting some degree of independence and objectivity, which he or she may not be getting.
MARC LAMONTAGNE: From the client’s point of view, the fee model offers full compensation transparency. Because of that, it is very clear for whom the advisor works: the client, [not] a third-party product provider. You are on the same side of the table as your client. The fee model allows the client and advisor to tailor the service to the fee they are paying; more fees usually equals more service. In some cases, the fees are deductible.
Experienced advisors can charge more than a rookie. That’s not always true in the commission model. If a client has a $100,000 to invest on a DSC basis, a rookie or a 20-year veteran will get paid exactly the same. It just makes good business sense for an advisor to have control over compensation, in the form of recurring fees.
Why do your clients like your business model?
REGAN: Simplicity, fairness and familiarity describe [the commission-based model]. It’s a single transaction, and there’s an embedded compensation or commission that’s paid. And yet a multitude of things go on between a client and advisor. I may speak to the client about her balance sheet, portfolio, tax position, goals and ambitions. But by executing a single transaction that initiates this plan, the compensation for all of those things I just described floats through a single transaction. This methodology of compensation is quite familiar to people; it’s the way the investment industry has been for a while. I’m a firm believer consumers need to know what they’re paying for and how the advisor is being compensated, no matter which structure is in place. Fairness [occurs when] my interests are aligned with your interests and there’s a fair exchange of value.
MACDONALD: The most common questions [we get] asked are: Do we only receive fees? Do we receive any form of outside compensation? Are we truly independent? Generally, this is a result of dissatisfaction with product-related advice. [We’ve] been in this business for almost 40 years. [Our] clients often express their appreciation of our longevity and consistency in being involved in their financial affairs and the achievement of their goals. It has been a relationship they have obviously been comfortable with and it has afforded them peace of mind.
LAMONTAGNE: Every time I speak to a client about a new investment, since I get paid the same whether the client chooses option A or B, he knows I don’t have a bias. You stop having to fight with your clients. On the other hand, if an advisor works on a commission basis or trailer-only model, he can’t say that. For example, the commission and trailer on a bond fund are half what they are on an equity fund. So there’s a built-in bias to build your clients more aggressive portfolios.
How much do you disclose about how you get paid under a commission-based model?
REGAN: Let’s start with the basic, [mandatory] requirement. The base document for the transactions involving mutual funds is a prospectus. A lot of people say the prospectus may be readily available, but it isn’t the easiest document to go through. Hence you’ve seen an evolution of something called the fund facts, which we’re developing along with others in the industry. [It will be] a two-page summary that allows for comparability of [all the] information a consumer might want, from fund objectives to fee structure.
But while that’s under development, you’re also obligated under the MFDA rules each time you discuss a mutual fund purchase with a client to disclose the method of compensation and the fee structure. Take the [front end] load versus the DSC, or no-load versus DSC approach. You have to describe that to a client and make notations about the discussion.
The MFDA is in the process of extending that rule. Not only will you have to disclose [compensation] at the point of sale, but also, in the case of a DSC transaction, you’ll have to disclose [compensation] at the point of redemption.
MACDONALD: Fee-only is 100% disclosure as the client is the only one paying the bills, and receives a written monthly bill articulating any charges.
LAMONTAGNE: My compensation is 99% fees, but I do sell the occasional insurance policy. There is no such thing as no-load insurance in Canada and in Ontario we cannot rebate the commission. So if I am recommending the client buy a policy, the service they are paying for includes the advice but not the placement of the policy. I have them sign a separate letter of engagement and disclosure explaining if I sell the policy, I will collect a commission. If they’re uncomfortable with that, they’re free to buy it anywhere.
Few in the industry believe Canadians will pay for financial advice exclusive of financial products.
REGAN: That’s not been tested empirically. People won’t necessarily do what’s in their best interests when faced with a decision to pull out the chequebook. In the financial planning context they might avoid seeking the advice necessary to help them out. They look at it as a short-term cost they don’t want to incur.
MACDONALD: [Our fee-only] model is not a myth, so clearly there are Canadians prepared to pay for independent, comprehensive financial advice. However, I expect most Canadians would say [they wouldn’t]. This is to a large degree [due to] a lack of understanding about the significant hidden costs they are currently paying.
LAMONTAGNE: I agree. Given the choice, most consumers would tend to pick a no-fee option. We tend to react poorly to the word “fee.” Once you are dealing with a more knowledgeable consumer, they tend to gravitate toward the fee model. I receive lots of calls from prospects who are specifically looking for a fee advisor. It is really a question of understanding the value of the service and what the total costs are, both transparent and opaque. I think if you explain that to clients, they will readily gravitate toward the fee model. Just ask any advisor who transitioned their client base and you will find that the vast majority of their clients agreed to the change.
Clients are a lot more interested in where their money is going now, including how their advisor gets paid. How has that impacted your business?
REGAN: There’s [definitely] heightened attention on fees and costs; [our clients and advisors] spend a lot of time discussing this topic. [We have] conversations with clients to help them understand, and we’ve really stepped up our emphasis on demonstrating the value of advice. We want our advisors to talk about it in a straightforward fashion. Don’t assume a client will know they’re getting value from you. Point it out. Make sure your value proposition is well understood. There’s actually empirical evidence that at all income levels and age groups, financial and peace-of-mind outcomes are more positive for someone with an advisor.
MACDONALD: We expect this [interest] will continue to improve the demand for our services. Clients are now much more aware and demand value for the money they are paying. They want transparency.
LAMONTAGNE: I certainly had to defend fees during the 2008-2009 bear market. It can be tough for a client to see their account balance go down from the market decline, plus fees on top of that. The experience forced me to be clearer on what the client is paying for. Clients are not paying for performance; they are paying for things such as ongoing advice, managing investments, monitoring, reporting and servicing.
Fee-for-service is the most transparent model, but if commission-based is more affordable, how does this play for a client who wants the best of both worlds?
REGAN: Rather than affordability, it’s value for money. Whether you pay upfront, write a cheque for a service, or pay in a fashion that’s embedded within a product, one way or the other you’re paying. You’re right that a fee-for-service might be more transparent in the sense of, “Here’s a cheque, and bang, I’ve paid for that.” But with [respect to] disclosure, an advisor [can] say, “Here’s the way I’m paid, here’s what happens on a DSC versus a no-load product,” in terms of compensation [and] fee streams.
There’s increasing awareness, and therefore increasing quality and frequency of dialogue, and increasing disclosure. So if there was a transparency gap historically, that gap is narrowing. But it’s really a value-for-money question and the consumer’s got to know what she paid for.
MACDONALD: Is the commission-based model more affordable? This isn’t always the case, especially when you take into account the scope and value of service, the hidden costs and compound nature of the commission-based model. [It] may be true initially at the low end of the mass market, but as assets accumulate, it’s often not. I concur: clients do not want to pay for these services, but often do not realize the costs paid in the commission-based model. I recall a prospective client with approximately $1.5 million in investable assets upset with the $7,500 quote to do a portfolio analysis and recommendations. He went elsewhere and invested his funds in mutual funds on a DSC basis. [It] cost him nothing, or so he thought. The broker earned $75,000, plus an ongoing annual trailer. This client only understood this three years later when he came back to see me, having cashed out his entire portfolio.
LAMONTAGNE: The beauty of the fee model is that you are selling a service for a fee. In the case where you have a fee-sensitive client, you simply offer him fewer services for the price he is prepared to pay. Some clients may prefer frequent meetings, and others only need to update their financial plan every three years. Professionals need adequate compensation even though the client may not grasp the value of services rendered.
How challenging is it to achieve a win-win scenario given your compensation model?
REGAN: A client wins when she meets her goals. [We] help to clarify those goals. This gets to the value of the advice discussions we’re holding with the client: it’s initiating and starting the movement from goal clarity to goal execution. That’s the value that comes from the [commission] model: when someone is willing and interested in engaging with you, you get a willing and interested client and [there’s a] great alignment between your outcomes. As your assets increase, I have an interest in that happening from a trailer perspective. But again, I disclose that to you. So when you win, I win.
MACDONALD: Fee-only is not for everyone and much of what we do is planning, the value of which is not readily apparent in the short term. Thus [our] clients are those with a longer-term perspective who see the value of having someone focused on them and the achievement of their goals. The challenge is to only accept clients with a longer-term perspective and commitment for whom we believe we can be of value. Our role [and] expected value [are] clearly discussed with the client before entering into a long-term relationship.
LAMONTAGNE: I think you have to choose your target market carefully. In my firm’s case, we chose to design a comprehensive service that includes financial planning, tax preparation, and investment management around a specific target market. As such, we focus on emerging affluent busy professionals and business owners. If you take
the time to design your service and pricing around your ideal client, you’ll find it easier to recruit those clients.
Doesn’t the commission-based model create a bias in cases where one mutual fund company pays a commission and the other one doesn’t?
REGAN: We don’t have that problem at Investors Group. Our business model has actually eliminated that risk by virtue of the way we run our product shelf. There are controls that mitigate that risk in the Canadian context: the regulatory requirement, oversights, know your product, know your client, and the regimes in the various dealers to watch transaction flows, asset concentrations, and the shifting in portfolios of clients. Those are daily activities that compliance operations undertake in every single dealer across Canada. You also have the general principle of client’s best interests. You do have the risk in every environment that people will operate at the fringe of what’s right, but the vast majority of advisors come at it with the client’s best interests [in mind]. Clients have multiple sources for their financial advice, so the competitive forces in the Canadian context make sure people are balancing competing interests in a practical way.
Consumers are developing into much more sophisticated individuals as a result of higher-quality disclosure, more awareness of the issues, and more awareness of the questions they want to ask. That in itself supplements and dampens that risk.
MACDONALD: I would like to think that the commission would not influence the advice given by an advisor, but I know that is not [always] the case.
LAMONTAGNE: We have a professional industry in Canada. If you ask most clients, they would tell you they are satisfied with the advice and service they are getting. Could it be better? If you are compensated on a commission basis, no matter how unbiased you think you are, the model puts blinders on your perspective. For example, you can only ignore evidence of the benefits of index investing for so long. When an advisor transitions to the fee model, the blinders come off and you see the benefit. The commission model is banned in the U.K. and Australia.
Do you think regulators in Canada are considering a similar action?
REGAN: No. I’ve had the privilege of having personal conversations with a number of the policy-making regulators at various jurisdictions across Canada. They’re aware of the issues in Australia and the U.K. in particular. They’re also acutely aware of the circumstances that gave rise to these issues [and] this policy formation in the U.K. and Australia. [It was] a particular set of dealerships with a particular set of products that gave rise to a level of disdain for the consumer that led to this kind of overreaction.
The regulators I talked to are looking for a made-in-Canada solution. So when they’re trying to understand what occurred, they’re also looking at where Canada comes from. And if they have any bias I would suggest it’s toward the development of disclosure models like the fund facts. So yes, they’re studying it, but I have not seen indications that [regulators] are marching down that path come hell or high water.
MACDONALD: As a fee-only advisor for almost 40 years, you might assume I would favour [the ban]. However, there should be a choice in the market, and if there were full and clear disclosure by those placing product, such draconian measures would not be required. It would be interesting to see how the early experience in these countries has been for consumers and advisors.
LAMONTAGNE: Well, the paternalistic Libertarian in me suggests that we don’t need to regulate everything, only things that are dangerous to our health and pocketbook. I don’t believe Canadian regulators will ban commissions, mainly because of the lack of a central regulator, which both Australia and the U.K. have. Most advisors are unaware that current regulation is built around the commission model and in some cases makes it difficult to charge fees.
Finally, is there enough room in the Canadian market for both models to coexist in harmony?
REGAN: Absolutely. Different people look for different things from advisors and advisory firms. These structures can happily coexist within the Canadian framework. The key is making sure consumers know their options and what’s behind any of the structures that would see them paying for services.
MACDONALD: I see no reason why not. I believe the big issue is 100% disclosure, written and verbal. The public is becoming much more aware. Over the last 40 years there have been significant improvements in the financial services industry, and there’s room for more. Continued public awareness will drive this.
LAMONTAGNE: Absolutely. Look at the U.K. The ban on commission-based advisors only applies to advisors who call themselves “independent.” Tied advisors (such as someone who works for Investors Group in Canada) are not subject to the ban.
Some regulations inherently favour commissions
The MFDA Dual Occupation rule lays out the conditions whereby an advisor can charge a fee directly to a client for producing a financial plan. If a mutual fund dealer is facilitating the sale of funds, the dealer may require all billing go through him, and keep a share of the proceeds as a commission.
The Financial Planning Standards Council’s rule 401 does not require disclosure of the amount of commissions fund companies pay to advisors.
The federal government introduced the Aggressive Tax Proposals in the March 2010 budget. These proposals would require an advisor to report to the CRA if his clients enter any tax minimization transactions if the transaction meets three hallmark conditions, one of which is whether the advisor has received a fee related to the transaction. Currently the AT proposals don’t consider commissions to be “fees,” and therefore commission-based transactions don’t meet a hallmark condition.