Three reasons why they may disappear
The late 1980s gave birth to the deferred sales charge (DSC) purchase option
for mutual funds. While the introduction of DSC funds coincided with the booming
growth of the fund industry, there are good reasons to expect its popularity to
wane - and maybe disappear.
Little more than fifteen years ago, it was common for advisors to charge
clients a front-end load of nine percent on all mutual fund purchases. Critics
of this structure argued that it promoted ‘churning’ of client accounts. In
1987, Mackenzie Financial unveiled the DSC purchase option, which not only gave
advisors an initial payment, but a small annual fee for ongoing service.
This had intuitive appeal, since a new relationship between client and
advisor usually entails a lot of work in the earlier stages. So an upfront fee
made sense - as did the smaller annual fee.
Soon all fund companies choosing to sell funds through advisors followed
suit, introducing DSC versions of existing funds - which ultimately led to fee
hikes to enable fund companies to finance the increased cost.
However, the following three trends all point to - at the very least - a
significant drop in DSC sales, and maybe waving goodbye to that option
As noted in
last week’s column, the fund industry remains in the consolidation phase.
Just imagine having invested a significant amount of money for a client in, say,
Synergy funds on a DSC basis just weeks before the announced takeover by CI
Mergers of fund firms always result in some product consolidation, which
means the manager you bought may no longer be around. However, the DSC purchase
just committed that investment to the firm for a full six or seven years.
No investor wants to feel trapped, particularly when the manager with whom
the money was invested (often a key factor) no longer manages the fund.
Wooing high net worth clients
Thanks in part to a tighter regulatory environment, operating costs for
distributors (i.e. advisory firms) have risen. This has led some firms, and most
individual advisors, to focus on marketing to the industry’s most coveted
client: the high net worth individual.
I would consider those with $500,000 or more of investable assets to be a
member of that highly sought-after group. Some might set the bar higher, at $1
million. Either way, the fact is that every advisor is pursuing wealthy
Canadians, which leads to a couple of reasons why DSC fund sales just don’t have
a place here.
Competitive forces are somewhat in favour of the high net-worth client.
Suffice it to say that there aren’t enough high net-worth clients to go around.
Hence advisors will have to compete on service and price - while really
excelling at one of the two.
Being competitive on price means there’s little chance DSC funds will be
feasible for wealthy clients. Just think of telling a $1 million client that
you’ll generate $50,000 in commissions, up front, from investing her money. Most
advisors would be hard-pressed to justify such a healthy payout based on the
work performed on the client’s file up to that point.
The other issue is one of client retention. A large portfolio invested mostly
or entirely in DSC funds is easy pickings for competitors. Another advisor can
easily pick apart such a portfolio with heavy criticism - and it would start
with fees and commissions.
Advisors wishing to compete in the high net-worth space have to be sensitive
to fees and commissions in dollar amounts because, one way or another, the
client pays for it.
Not only will competing advisors scrutinize portfolios, but so will investors
as they become more educated and aware - due in part to increased regulation.
Further, with high net-worth investors, portfolio proposals must often be
presented to the client and his accountant. In this case, documentation can be
I worked on a case this past spring where an advisor was to propose a
portfolio for a $1-million account. The client insisted that her accountant be
present. I designed a portfolio and drafted an investment policy statement. A
small amount of DSC was recommended, but it was an amount that was determined
according to the work required up front for analysis, client meetings, and
Every detail was documented and fees were the first issue addressed. The
accountant was impressed, as was the client, who later accepted the proposal. In
such a case, a significant amount of DSC would have been tough to justify.
These issues aside, a variant of the old DSC is gaining popularity: the
“short DSC” or “low load” option. This involves a commission payment of 1 to 2
percent, plus a trailer fee that is equal to that applicable on front-end
purchases. It’s not a bad compromise, since it provides an up front payment, but
only ties up the client for two to three years - rather than six or seven.
The trends noted above present a good case for why DSC fund sales are likely
to dissipate as the industry evolves. Advisors would be smart to prepare now for
changes before they’re forced to adjust.
Dan Hallett, CFA, CFP is the President of Dan Hallett and Associates Inc., an independent investment research firm based in Windsor, Ontario. Dan can be reached at firstname.lastname@example.org.