Advisor-class exchange-traded funds -- a Canada-only oddity in the global ETF industry that first appeared here more than a decade ago -- are becoming increasingly rare.
Two firms that until this year had offered advisor-class ETFs -- which pay embedded commissions to brokers -- have bowed out. Two others -- most notably BlackRock Asset Management Canada Ltd. with its market-leading iShares family -- continue to make this purchase option available for some of their ETFs.
Embedded commissions, mostly in the form of trailer commissions that fund companies pay to brokers and dealers for as long as an investor holds a fund, have sparked controversy in the investment industry, with securities regulators proposing that they be banned and large segments of the fund management and advisor communities strongly opposed. Though these commissions are paid by most traditional open-end mutual funds, they're an anomaly among the more than 500 ETFs now on the market in Canada and their total $130.5 billion in assets.
As regulators continue to deliberate whether to impose a ban on paying for advice with commissions embedded within fund fees, the First Asset and Horizons families of ETFs have taken matters into their own hands.
In July, First Asset Investment Management Inc., a subsidiary of CI Financial Corp. (CIX), eliminated all advisor-class units by converting them into the lower-fee common-class units of the same ETFs.
In addition to First Asset's intention to stay ahead of the curve in terms of a potential ban, the firm said advisor-class units were eliminated because of low investor demand. In a statement released on April 3, First Asset noted that advisor-class units represented less than 2% of its assets under management, and the firm anticipates that "the changing regulatory environment will continue to reduce the demand for these units."
First Asset's action followed closely on the heels of Horizons Exchange Traded Funds Inc., which eliminated its advisor-class units earlier this year. Horizons' co-CEO and chief investment officer, Steven Hawkins, believes "embedded commissions will be banned by the CSA (Canadian Securities Administrators). The rest of the industry will have to follow either mandatorily or at their own will."
As part of an effort to increase transparency in the industry and address compensation-related conflicts of interest, the CSA released a consultation paper in January, seeking input from the investment community and other interested parties. The paper, titled Consultation on the Option of Discontinuing Embedded Commissions, received more than 140 submissions, which have been under review since June.
As part of the CSA's consultation process, the Ontario Securities Commission will conduct a series of roundtable discussions on Sept. 18 to examine the potential impacts of discontinuing embedded commissions. Among the invited panellists is Warren Collier, managing director and head of iShares at BlackRock Canada.
Out of about 117 Canadian-listed iShares ETFs, 28 currently have advisor-class purchase options. Their combined assets of $513 million represent less than 1% of BlackRock's $55.3 billion total as of July 31. The only other ETF firm continuing to offer advisor class is FT Portfolios Canada Co., operating as First Trust, whose eight advisor-class ETFs have a combined total of $56 million in assets.
In a June submission to the CSA which Collier co-authored, BlackRock Canada said it agreed with the regulators that "transitioning away" from embedded fund commissions would probably result in more assets being allocated to lower-cost products, and more lower-cost product providers entering the market. To enable this to occur, BlackRock called on the regulators to address regulatory barriers including "cumbersome disclosure requirements, outdated rules and rigid registration requirements."
BlackRock's advisor-class ETFs are a legacy of its 2012 takeover of Claymore Investments family of ETFs, which were integrated into the iShares family. Claymore, led by founder and then-CEO Som Seif, pioneered advisor-class ETFs in 2006.
Seif subsequently founded Purpose Investments Inc. and came up with another innovation: prospectus-sold investment funds that are available either as mutual funds -- with the availability of trailer commissions -- or as ETFs with no embedded compensation.
In an interview with Morningstar, Seif emphasized the importance of a mutually beneficial relationship between clients and advisors, and that embedded fees are sometimes a better option for investors. "Taking out trailer fees doesn't solve the real problem, which is moving to a best-interest standard where the advisor's role is exclusively focused on supporting the client's best interests."
If an advisor gets compensated only with trading commissions, says Seif, they may be motivated to trade more often instead of staying committed to an investment vehicle for multiple periods. "Let's take the question of compensation off the table and allow the advisor to make that decision with their client."
Seif noted that securities regulators effectively increased fee transparency in the fund industry with the Client Relationship Model, Phase 2 provisions that took effect in July 2016. By making it mandatory for fund dealers to disclose the dollar amount of trailer commissions paid to the dealer out of the funds' management-expense ratios, "CRM2 has created an environment where disclosure is there," he said.
A prominent ETF firm that has been outspoken in its support for a ban on embedded commissions is Vanguard Investments Canada Inc., a subsidiary of the giant U.S.-based Vanguard Group. "We believe that greater transparency leads to better outcomes for investors," says Matt Gierasimczuk, public-relations manager at Vanguard Canada. "By eliminating trailer fees and commissions, you remove any potential conflict of interest."
In Vanguard's submission to the CSA, Atul Tiwari, managing director of Vanguard Canada, says that by banning embedded commissions, Canada has an "opportunity to join a global trend aimed at improving investor protection and transparency. We have seen this take root in the U.K., Australia and the Netherlands, leading to greater investor outcomes including lower investment fees, greater product access and enhanced fee transparency."
