© Copyright 1998
The Globe and Mail
Reprinted without permission
BY SHIRLEY WON
Investment Reporter
CHRISTINE Ermarkaryan invests in mutual funds but refuses to pay front-end or back-end commissions.
She started buying no-load funds from a bank and direct seller Altamira Investment Services Inc., but then wanted to diversify her holdings to add popular load funds.
That's how she became a client with Toronto-based E Trade Canada, an electronic brokerage firm, which sells commission-free funds. Since opening a self-directed RRSP, she has added load funds such as Trimark Canadian and Trimark Fund, and no-load fund Scudder Canadian Equity.
She and her husband, Arno, 34, a software engineer, like being do-it-yourself investors partly because they have business backgrounds -- both hold MBAs.
"We like to do our own research, and we think there is enough information out there to help us make our decisions," says the 30-year-old chemical engineer.
Mrs. Ermarkaryan -- who does her trades using her personal computer -- is one of a growing number of investors who are turning to zero-fee dealers because they don't like commissions eating away at their returns.
While these players are attracting converts, some industry observers also warn that this kind of service isn't for everyone. Some people could also end up in worse shape financially by making their own investment decisions.
The advantage of buying a front-end load fund is that it gives you the flexibility to sell at any time, or within three months. Buying a back-end load fund means you could be hit with a hefty declining sales charge if you redeem early.
In Canada, some zero-fee dealers have been small firms targeting this niche. The Ontario companies include Mutual Fund Direct Inc. of London, Sterling Mutuals Inc. of Windsor, The Mutual Fund Exchange of Concord.
But national discount brokers, which also sell stocks and other securities, have jumped into the fray. CT Securities Inc., the discount-brokerage arm of London, Ont. based Canada Trust, recently became the first Canadian major banking institution to do so.
E Trade Canada, operated by Versus Brokerage Services Inc., began its commission-fee deal last September. And Altamira Investment Services also said this week that its brokerage arm is exploring the option of selling third-party load funds with no fees.
The zero-fee dealers are challenging bank discount brokerage players such as Green Line Investor Services, a subsidiary of Toronto-Dominion Bank, which charges a 1- to 2.5-per-cent front-end load fee. A full-service broker could charge up to a 5-per-cent fee depending on your bargaining power.
So how do these mutual fund deep discounters make money? The answer lies in the "trailer" fees that fund companies usually pay quarterly to all dealers for giving continuing "service" to clients. These fees can range from about 0.15 per cent for money market funds to about 1 per cent on a stock fund.
Zero-fee dealers typically allow one to switch funds within a family without fees but they differ in other ways.
CT Securities, for instance, requires a $15,000 minimum balance in your account, while others don't. Stephen Kangas, vice-president of external funds for Canada Trust, acknowledges the minimum is there because his firm sells its own proprietary no-load funds that clients would typically buy before wanting to diversify.
Some dealers such as E Trade Canada won't charge a commission on all load and no-load funds, while some -- such as Canada Trust -- may charge a fee on some no-load funds. E Trade and some others won't charge a fee on the no-load funds sold by Bissett Associates Investment Management Ltd. and Phillips Hager & North Investment Management Ltd. even if the companies do not pay trailer fees.
Some dealers require investors to hold a fund for at least three months because that is usually the minimum required holding period before a fund company will pay the trailer fee. For example, Mutual Fund Direct has a 1-per-cent penalty fee for cashing in prematurely.
And Affinity Group has a different twist in that it targets certain groups -- such as the alumni and staff at some universities and card holders with American Express Canada Inc. It shares the trailer fees with those organizations.
Colleen Moorehead, president of E Trade Canada, which opened for business in January, 1997, says there is growing interest in buying load funds with no commissions. Mutual funds have grown to 23 per cent of her firm's daily trades from less than an average of 11 per cent during the first eight months in 1997.
"Mutual fund assets now represent 36 per cent of our assets that include stocks, bonds, options and other securities -- up from 15 per cent prior to last September," Ms. Moorehead says.
Zero-fee dealers cater to investors who don't want to go to a financial adviser -- who are paid by commission -- because of concerns they may not be getting "unbiased" information, she adds.
Catherine Hanley of Ottawa, a former federal public servant who took a buyout package two years ago, says she became a client of Sterling Mutuals after becoming "fed up" with two advisers -- a stockbroker and a financial planner.
Ms. Hanley says she was "green" when she met the broker. He put her into back-end load funds in 1993 but did not explain the "declining" charges. When she wanted out of some non-performing funds, she was hit with "switching fees."
Because she did not want to deal with 6-per-cent backend load funds, she found a financial planner who told her he would charge zero front-end commissions but actually put her into some back-end load funds again. She protested to management because she had it "in writing" and her funds were repurchased for her on a front-end basis.
But she also disagreed with that financial planner who wanted her to redeem her AIC Advantage Fund, which invests mainly in the stocks of wealth management companies, and she saw no need to do so. "I'm in it for the long haul for that one," she says.
Ned Goodman, chairman and chief executive officer of Dynamic Mutual Funds, acknowledges there are some people who are able to be do-it-yourself investors but contends most should have an adviser.
"The majority of people today buying mutual funds are not sophisticated investors," Mr. Goodman argues. "They have all had pretty good experience with funds because the markets have been good to us."
Many so-called "GIC refugees" fled to bank no-load bond and mortgage funds but "got their head handed to them on a block" in 1994 when their funds took a beating after a hike in interest rates, he recalls.
Mr. Goodman says his beef is that many investors who use zero-fee dealers will panic if stock markets go through a severe downdraft, and end up calling mutual fund firms such as Dynamic for handholding. But that is the job of the advisers who are being paid through the trailer fees, he says.
"We used to be a no-load fund group [from 1957 to 1986] but we switched to load funds because we found we couldn't handle the volume of calls," he says. "Everybody is an expert until something strange happens in the stock market and then they become frightened and need someone to talk to."
While trailers are typically paid for continual service, zero-fee dealers say it doesn't have to be conventional face-to-face meetings. E Trade Canada maintains it can also mean the investment tools -- such as an asset-allocation model or fund-search feature -- that it offers on its mutual fund Web site.
Warren Baldwin, a Toronto-based fee-only financial planner with T.E. Financial Consultants Ltd., which does not sell investment products, warns that do-it-yourself investors can easily end up making too many mistakes.
These investors can run the risk of chasing yields -- that is, buying last year's star funds. "Last year's hottest funds can quickly become this year's coldest funds," he warns.
Some investors can also end up having too many funds in a portfolio because it's human nature to want a bit of variety, he says. "You can overdiversify and it's too many things to watch." .
Because these investors are not getting advice, they might not have an appropriate asset mix of stock and fixed-income funds and international and Canadian funds he says.
With amounts like $50,000 to $100,000, one should try to have a tax-effective asset mix so that stock funds are outside a registered retirement savings plan, while the higher-taxed gains from fixed-income funds are inside an RRSP, he notes.
But Mr. Baldwin adds that users of the zero-fee dealers might also be those who pay fee-only planners -- such as himself -- for advice, but "then the people go away and do the stuff on their own."
Shop around for a zero-fee dealer because they do differ. Just remember you must have time to do your research and also weather stomach-churning market downturns on your own.
Current On-line Onetime
Dealers location* Restrictions ** trading set-up fee Phone/website
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CT Securities Inc., All provinces Balance of $15,000 required in Yes - 1-800-530-9000
(Canada Trust) except Quebec brokerage account. Must make www.ctsecurities.com
minimum $2,500 purchases or a
minimum investment of $500
with $200 monthly contributions.
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E Trade Canada All provinces Minimum balance of $1,000 in Yes - 1-888-TRADE88
except Quebec account. Can make monthly www.canada.etrade.com
contributions of $100.
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Mutual Fund Ontario, Must make minimum $1,000 Later $45 1-800-268-1066
Direct Inc. Alberta purchase. in year www.no-loads.com
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Sterling Ontario, - Yes $40 1-800-354-4956
Mutuals Inc. BC www.sterlingmutuals.com
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The Mutual Ontario Must have a minimum family No - 1-800-493-FUND
Fund Exchange account balance of $5,000. www.mutualfundex.com
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Affinity Group Inc. Ontario - No $45 1-800-807-1602
www.fundsource.com
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* Most dealers will be adding other provinces later this year or in the future.
** Restrictions other than minimums required by fund companies.
Source: Companies