It's hard to imagine a less compelling case for regulatory relief than the Mutual Fund Dealers Association's current proposal to allow dealers, for the first time, to make discretionary trades for their clients. The self-regulatory organization's proposed rule changes, which would apply only to dealer-administered fund-of-funds programs, were released in April for a 120-day comment period that ended on Aug. 2. The MFDA hasn't specified a target date for implementing rule changes.
There’s certainly no urgency, given that fund dealers already have access to an abundance of fund-of-funds portfolio programs and asset allocation services offered by the companies whose funds they distribute. The fund companies' multi-asset offerings are professionally managed by qualified personnel who meet all regulatory requirements. They're offered by prospectus to retail investors. Their performance rankings and ratings are readily available.
All major fund providers, including bank-owned firms and independents, offer fund portfolios. Along with balanced funds, they're perennially the most popular type of mutual fund purchase. In addition, recent years have witnessed the emergence of the robo-advice industry, in which portfolio management firms provide ETF portfolios to online clients on a discretionary basis.
The commoditization of investing, through packaged portfolios created for multiple clients, is the prevailing trend. These asset-allocation services require clients to first complete a questionnaire to determine their investment objectives, risk tolerance and time horizon. All clients who fit a particular risk-return profile are placed in the same model portfolio.
Fund dealers that are subsidiaries of major banks have access to proprietary funds of funds, so they're fine with the status quo. The independent MFDA dealers, however, want their very own piece of this fund-of-funds action. Dealer-administered fund-portfolio programs would bolster the dealers' brand identity and help set them apart from competitors. They'd still need the mutual fund companies, but only as suppliers of individual funds, not as portfolio architects.
If MFDA representatives were given authority for discretionary trading, the fees that the fund companies charge for fund-of-funds portfolio management, administration and dealer support would instead be retained internally. This would benefit the dealers' bottom lines. As for their clients, there's nothing in the MFDA's proposal to indicate that cost savings, if indeed there were any, would be shared with investors.
Their lack of discretionary authority is the major hurdle that MFDA dealers need to overcome in order to compete with fund companies and robo-advisors on fund portfolio programs. As it now stands, any addition or deletion of a component fund by an MFDA dealer, or any change in the target asset mix, would require the client's consent.
The MFDA says obtaining permission for changes in portfolios owned by multiple clients would be costly and inefficient. This would be to the detriment of investors, the MFDA argues, because dealer-initiated changes aimed at improving the quality of component funds or responding to market developments would be impeded.
Besides, the MFDA says, it's proposing only "limited" discretionary trading. What this means is that its scope would be confined to the portfolio program, and that changes in the underlying funds or the asset mixes would need to be within the "pre-established parameters of the mutual fund model portfolios offered by them." The MFDA's proposal lacks any specifics on what these limits should be.
It's also unclear how the proficiency and other standards for MFDA dealers making discretionary trades would compare to those of Investment Industry Organization of Canada (IIROC) registrants who have obtained the advanced designation as portfolio managers. In managing discretionary accounts, the IIROC-registered advisors are held to a fiduciary standard of acting in the client's best interests.
Perhaps the most controversial aspect of the MFDA's proposal is the lower "standard of care" that it contemplates for discretionary trading. The fiduciary standard is the strictest in the investment industry, but it's not what the MFDA apparently has in mind.
Portfolio-management trade groups and investor advocates, in their submissions to the MFDA, oppose lowering the bar for mutual fund dealers who want to make discretionary trades. The Canadian Foundation for Advancement of Investor Rights (FAIR Canada), for one, isn't inclined to support any regulatory relief.
FAIR Canada recommends, in its submission to the MFDA, that dealers who are allowed only limited discretionary trades should still be held to "a fiduciary duty to act with care, honesty and good faith and to put the clients’ interests first." Factors such as compensation to the MFDA firm or to the individual advisor should not be allowed to influence investment and trading decisions, FAIR Canada says.
For its part, the Portfolio Management Association of Canada insists that the standards that apply to its members, all of whom are fiduciaries, should also apply to discretionary trades by fund dealers. "PMAC strongly believes that all registrants entrusted with managing client assets on a discretionary basis should owe those clients a fiduciary standard of care," the association says in its submission.
PMAC also takes issue with the notion that one standard of care would apply to the mutual fund portfolio, while a lesser standard would apply elsewhere in a client's MFDA relationship. "PMAC believes it is inappropriate to treat the fiduciary duty as a transactional duty."
A fiduciary standard, as also advocated by the Ontario Securities Commission's investor advisory panel, would be problematic for MFDA dealers. The very existence of a proprietary fund-portfolio program creates potential conflicts of interest.
On what basis would a dealer, presumably acting in the client's best interest, recommend the in-house portfolio program over a well-established third-party program managed by a fund company such as AGF, CI, Fidelity, Franklin Templeton, Invesco or Mackenzie?
Wider selection of funds and fund managers? Potentially yes, but this too is nothing new. Multi-manager fund programs that are widely available to retail investors include RBC Select Portfolios, Scotia Partners Portfolios and Sun Life Granite Managed Solutions.
To run its own multi-manager program, an MFDA dealer would need to hire analytical expertise to make fund picks and asset allocation decisions. Yet the MFDA doesn't want its members to foot the bill for compliance requirements that apply to every other discretionary advisor in Canada.
Lower costs? This, too, is doubtful, given that the brand-name fund managers have greater economies of scale to bring to bear, from both within their organizations and because of their wider distribution networks. Dealer-managed fund programs, sold only by their own representatives, would have less scope to achieve these economies.
Track records? Fund programs started up by MFDA dealers to take advantage of their new discretionary authority wouldn't have any past performance to evaluate. But in fairness to the MFDA, you could say this about any new fund-of-funds offering.
The difference, however, is that as time goes on, performance numbers of fund-company programs can be compared with competing offerings, through independent data providers such as Morningstar. Would dealer-managed fund programs provide their performance data to the Canadian fund-measurement firms that are Canadian Investment Funds Standards Committee (CIFSC) members? That, too, is unlikely.
To sum up, the MFDA hasn't made the case for why the marketplace needs more fund-of-fund portfolios to choose from beyond what's already out there. It follows, then, that there's no justification for lowering the standards for which individual advisorsshould be entrusted with discretionary power over client assets.
