Back-end loads unbundled
January 25, 1999
Bonus units on deferred load funds, launched this month by discount brokerages, have opened up a new front in price competition. Since the introduction of the first deferred load funds in Canada in 1987, all types of intermediaries -- whether full service advisors or discounters -- have collected exactly the same amount of commission paid directly to them by the fund companies.
Now at least five sales organizations, including four major bank-owned discount brokerages, have decided to share those payouts with their customers. First off the mark was a small Ontario dealership called the Fund Company, a subsidiary of Toronto-based fund manager University Avenue Financial.
Fund Company president David Miner said his firm is offering two percent bonuses to investors in deferred load funds, and three percent to households with at least $50,000 (Canadian) to invest. The bonuses are paid in the form of additional units, and are subject to capital gains tax on redemption.
Soon after, Bank of Nova Scotia's Scotia Discount Brokerage became the first major national organization to offer bonus units. It upped the ante with a 2.5 percent bonus for orders of at least $2,500 per fund, and three percent for orders received via the Internet.
Though Scotia estimates it has less than a ten percent share of the discount brokerage market, its heavily advertised program brought a prompt response from Toronto Dominion Bank's Green Line Investor Services, which dominates the discount brokerage business with an estimated market share of 60 percent. Within hours of Scotia's announcement, Green Line said it would match the 2.5 percent bonus, and extend it to purchases as small as $1,000.
Subsequently, Royal Bank of Canada's Action Direct undercut everyone with a 2.75 percent bonus, and Bank of Montreal's InvestorLine joined in with a 2.5 percent offer.
"We need to remain competitive on a pricing basis," said InvestorLine president Bruce Schwenger.
Scotia Securities president and ceo Andrew Scipio del Campo, in charge of Scotia's discount operation, described the bonuses as a revolutionary move aimed at the growing ranks of do-it-yourself investors.
Deferred loads are by far the most popular choice for investors who buy load funds. According to Scotia, purchases of deferred-load funds totaled an estimated $38 billion in Canadian dollars last year, and total commissions payable amounted to some $1.9 billion.
"This marks the first time that a major financial institution is sharing this commission with its customers," Scipio del Campo told a press conference. He added that, along with giving customers an immediate boost in the value of their investments, the bonus program will help educate them about how the industry prices its services.
Green Line president John See said his firm's bonuses were an opportunity to build its sales of deferred-load funds and give customers another reason to do business with Green Line.
"It's a concept whose time has come," he said. Green Line's bonuses reflect the trend toward lower fees and more "transparency" of mutual fund fees, See said.
The bonus programs follow the recent outbreak of a price war among no-load providers of index funds led by Royal Bank of Canada's Royal Mutual Funds and independent direct seller, Altamira Investment Services.
The fee cutting has been confined so far to the no-load fund firms. But there does appear to be a modest ripple effect. Mackenzie Financial, the largest load fund firm selling through independent brokers and dealers, said it is planning to introduce new classes of fund shares that will offer lower fees for larger accounts.
Phil Cunningham, president of Mackenzie's main operating subsidiary, said the company has no plans to reduce management fees across the board. Cunningham defended his company's management fees (normally two percent for equity funds) as justifiable because of the broker's commission which comes out of the fee and the higher costs of active money management compared to indexing.
Another load fund executive, Dundee Mutual Funds president Terence Buie, views the recent price skirmishing on no-load index funds as the beginning of a price war in that sector. Buie said firms such as his are not directly affected because they rely on full-service advisors. The real issue in the future will be whether investors who purchase advice are getting value for their money, he said.
Meanwhile, Toronto Dominion Bank's mutual fund arm has held off on reducing its index fund fees to compete with the new low cost providers, Royal and Altamira.
"We will not immediately respond, but when we do respond it will be in an industry breaking way," said TD Asset Management president Mark Wettlaufer. "I'm using it as a catalyst for a pretty serious rethink about how we do business."
Wettlaufer said that because of higher pay for fund wholesalers and a heavy burden of paperwork imposed by regulators across the country, fund distribution is more expensive in Canada than in the U.S. He said he is exploring how distribution costs can be reduced so that savings can be passed on to customers in an economically sustainable manner.