At the end of 2016, 11.3% of Canadians’ investment fund assets were invested in index
funds and similar passively managed products.
Our neighbours in the United States are ahead of us, with 34% of their investment fund assets
invested this way.
In 2016, Canadians added $10.9 billion to passive funds, and $10 billion to actively
managed funds... Pretty even.
In the U.S., investors added $490 billion to passive funds, and removed $326 billion
from actively managed funds.
The evidence is clear, our neighbours down south are catching on, and Canadians are intelligent
people, so what’s going on?
I’m Ben Felix, Associate Portfolio Manager at PWL Capital.
In this episode of Common Sense Investing, I’m going to explore why Canadians have
been slow to adopt index funds.
Put yourself into the shoes of an average Canadian getting started with investing.
Where do you go?
Well, if you are the average Canadian, you probably go to your bank.
Sounds like common sense, right?
Well...let’s see….
Canadian banks don’t generally train and incentivize their financial advisors to sell
index funds.
They train AND incentivize them to sell their actively managed funds, which have higher
fees and are more profitable for the bank.
And we know how relentless the banks are in ensuring their profitability.
;)
If you don’t go to the bank, you might look online or ask a friend for an introduction
to a financial advisor.
There are plenty of non-bank independent financial advisors in Canada.
The compensation model for these advisors has generally been commission-based for a long time.
It’s only very recently that financial firms have started offering and promoting other
compensation models.
As it stands now, many financial advisors are still paid by commission associated with
the high-fee mutual funds that they sell.
Index funds do not generally pay commissions.
I’ve talked a little bit about the incentives that might be keep dollars flowing into actively
managed funds in Canada.
The other important factor is our regulatory environment.
In the United States, Registered Investment Advisors have been seeing massive growth,
and are currently managing around one quarter of investment assets in the United States.
This specific type of registration requires the advisor to act as a fiduciary, in other words:
to act in the best interest of their client.
This may seem obvious, but Canadian financial advisors do not generally have a fiduciary
requirement - they have what is called a "suitability requirement"
What does that mean?
Well, if an advisor in Canada recommends a high-fee mutual fund that will pay them a
large commission, but it is “suitable” based on the client’s situation, the advisor
is operating within the law.
See how that isn’t ideal?
The suitability standard’s partner in crime has been, until recently, lax requirements
on fee and performance disclosure.
Many, if not most, investors have not known for many years,
how much they are paying in fees or how their
investments are doing, and advisors have not been required to explicitly state those figures.
New disclosure now requires financial firms to send their clients an annual report disclosing
the total fees the client has paid to the firm, and the performance that their investments
have delivered.
Between incentives and compensation structure that heavily favour high-fee actively managed funds, lack
of a fiduciary requirement for advisors, and, until recently, lacking fee and performance
disclosure rules, it is no wonder that Canadian investors have not been pulling money out
of actively managed funds and moving it into index funds at the same pace as our neighbours
across the border.
Join me in my next video where I explain why actively managed funds have such a hard time
beating the market.
My name is Ben Felix of PWL Capital and this has been Common Sense Investing.
I’ll be talking about this and many other common sense investing topics in this series,
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I’d also love to hear from you as to what topics you’d like me to cover.