Investors have been exiting commission-based balanced mutual funds, opting for lower-fee alternatives.Sadeugra/iStockPhoto / Getty Images
Sign up for the Globe Advisor weekly newsletter for professional financial advisors. For more from Globe Advisor, visit our homepage.
Canadian investors are shifting out of high-fee, commission-based balanced mutual funds toward lower-fee options as rules around fee transparency gain traction and investor attention.
A recent report from Morningstar Canada on balanced funds found that commissions-based advice share classes of balanced mutual funds had outflows of $74-billion from the beginning of 2022 through December, 2023.
In contrast, fee-based mutual funds had inflows of $6-billion over the same period, while balanced exchange-traded funds (ETFs) saw $3-billion in inflows.
Retail assets in balanced mutual funds at the end of 2023 totalled more than $735-billion, the Morningstar Canada report said, making it the second-largest category in Canada, but inflows over the previous five years totalled less than $1-billion.
The report notes that the trend in balanced funds coincides with the implementation of the client-focused reforms (CFRs) in December, 2021, which increased fee transparency and advisors’ know-your-client and know-your-product requirements.
“This is evidence that the CFRs are achieving their desired effects: When Canadians get more information about the fees they are paying, they choose cheaper and simpler options,” the Morningstar report states.
The redemptions in 2022 also coincided with balanced funds suffering as both equities and bonds were hit by rising interest rates. Michael Dobson, a manager research analyst with Morningstar Canada, says it’s not surprising that investors pulled the plug and sold their commissions-based balanced funds in that environment.
“When you’re selling funds – kind of like when you’re budgeting or trying to cut costs – you cut out things that are the most expensive, and commissions-based advice gives the least flexible pricing options and ends up being the more expensive,” than fee-based balanced funds, he says.
The shift to fee-based funds was expected, the Morningstar report notes, “as fee-based share classes allow investors to negotiate advisor compensation separately while commissions-based share classes can have more complex and expensive arrangements.”
The trend has continued this year, according to data from the Investment Funds Institute of Canada. In the first half of 2024, investors sold almost $19-billion in balanced mutual funds, while balanced ETFs saw inflows of $2.3-billion over the same time frame.
Commissions-based funds have fees of about 2 per cent while fee-based funds are closer to 1 per cent; exchange-traded funds (ETFs) can be closer to 0.20 per cent, according to the report.
“Generally speaking, fees are the most consistent detractor from performance,” Mr. Dobson says.
One takeaway from the report is that many Canadians may not be aware there are cheaper options available to them within balanced funds, Mr. Dobson says. Commissions-based funds are seeing outflows but fee-based funds haven’t made up the difference.
While reforms that increase the transparency on the fees investors pay are having an impact, “the progress is still pretty slow,” he notes. Many of the largest balanced funds are still those from the Big Six banks, many of which are commissions-based. Some people have been invested in certain funds for years and don’t want to change or aren’t aware of the fee.
ETFs gain from mutual fund pain
Balanced ETFs grew to $15-billion in assets under management (AUM) at the end of 2023 from $2.9-billion in 2019, the Morningstar report says, with the number of balanced ETFs in Canada jumping to 66 from 25.
When fund giant Vanguard Investments Canada Inc. launched balanced portfolio ETFs in 2018, it put pressure on other balanced ETF and mutual fund providers to reduce fees, which was dubbed the “Vanguard effect.”
“We believe firmly in advice, but it has to come at a reasonable cost,” says Sal D’Angelo, head of product for Vanguard Canada. “For some, 2 per cent may be okay, but for others, that might be high. Some clients who feel they don’t need the advice, they’re fine to do it on their own.”
While mutual funds are still huge, more investors have turned to low-fee F-class funds as fee transparency has taken effect, Mr. D’Angelo says. And that could continue with the next phase of total cost reporting coming into effect in 2026, when dealers will have to show the advisor fees as well as the product manufacturing fees, he adds.
Going global
Investors are also moving away from balanced funds focused primarily on Canadian securities in favour of more globally diversified options, the Morningstar report says.
Canada accounts for less than 3 per cent of the global stock market, but Canadians continue to hold about 50 per cent of their equities in Canadian stocks, Mr. D’Angelo says.
“It’s a huge overweight to Canada, but that comes with risks – sector risk, concentration risk – and I think more Canadians are getting familiar with global markets and understand the benefits of global diversification,” he says.
The strength of the U.S. market is also a big driver of this change as investors saw what they could miss out on if they didn’t invest outside Canada, he adds.
Vanguard released a home bias report last month and found that an equities mix of 30-per-cent Canadian and 70-per-cent foreign was the risk-return optimization point based on sector diversification benefits, and liquidity and taxation considerations, Mr. D’Angelo says.
Andrew Clee, vice-president of product with Fidelity Investments Canada ULC, says both its balanced mutual funds and ETFs continue to sell.
Fidelity is the second-largest balanced fund provider in Canada with $81.3-billion in AUM at the end of 2023, according to Morningstar, behind RBC Global Asset Management with $147.2-billion.
Three years ago, Fidelity created its all-in-one global balanced ETFs, which are managed actively.
“They’re our best-selling suite of ETFs year to date,” Mr. Clee says, with about $2.5-billion in AUM. “It does speak to the power of active management portfolio construction.”
Mr. Clee adds that there’s a place in every portfolio for both ETFs and mutual funds, and Fidelity is “vehicle agnostic,” with offerings in both. There are benefits to each type of investment vehicle, with mutual funds making it easier to execute pre-authorized contributions and dividend reinvestment programs, he adds.
For more from Globe Advisor, visit our homepage.