Mutual fund practices look a bit like Ponzi schemes

There is something about Canadian mutual-fund industry numbers and practices that are troubling this retail investor. Some numbers don't add up and the industry talks to us in a language I call "fund-speak" about mysterious stuff like "trailers" which are hitched to "MERs."

The Investment Funds Institute of Canada (IFIC) says "assets under management by the . . . industry were $652.5 billion at June 30, 2009." About 47 per cent of us owned them, directly or indirectly, in 2008. We're talking about very big money and roughly half the Canadian population here.

Some of their numbers appear "fudged," as if to say that 10 plus 10 can equal 15. It's like asserting the world is both flat and round and Canada geese fly at the speed of light.
Last Sept. 16, the Bank of Montreal mutual fund web site reported its BMO Monthly Income Fund units (or shares) went up in value by eight-tenths of a cent that day to a new price of $8.2184. But if you checked the previous day's reported value, on the same web site, the price that day was $8.2704. So if you subtracted 8.2184 (on the 16th) from 8.2704 (on the 15th) that's a drop of .052 cents and not an increase as claimed.

The numbers simply did not compute, no matter how many provincial securities-commission officials and statisticians explain that up can also be down simultaneously.
Another aspect of the roughly 2,000-fund industry is a thing called a "trailer" which is sometimes attached to a "MER." It is pronounced "merr" and stands for "Management Expense Ratio."

Trailers and MERs? Not terribly informative, you say. Hey, have you ever read mutual fund prospectuses cover-to-cover and lived to talk about it? They make train and bus schedules look exciting and easy to understand. Making prospectuses simple to grasp appears very low on the industry agenda, perhaps deliberately so.

The MER is what the fund company charges you to manage the fund. MERs run in the area of about one or two per cent of the value of the fund every year. Some MERs are higher, some lower.

Let's say one of your funds' MER is 2.5 per cent. The trailer portion may be a quarter to a third of that. The trailer is paid to your financial advisor as a sort of reward (or fee or commission) for keeping you and your money in that particular fund. Different funds pay different rates of reward. Some pay none at all.

Google this: "The Truth on Trailers" (including quotation marks). It will take you to an article by John DeGoey of Assante Capital Management Ltd. The item mentions the word "bribery."

Trailers remind me of how the issuers of toxic mortgage-backed securities in the United States got triple-A risk ratings from the securities-rating agencies on effectively garbage, triple-Z assets. That was because the issuers paid for the ratings.

It's simple. You pay the piper. You call the tune.
The next time you're talking to your financial planner cum advisor, ask him/her how much he/she received last year in trailer rewards based on your investments. You may be shocked at who may be calling the tune.

In my view, trailers are a huge potential conflict between the interests of the investor and those of the advisor. If not prohibited altogether, the rewards should be reported by advisers to clients in writing at least quarterly, openly and in simple - repeat simple -- English.

The mutual fund industry in Canada is regulated by the provinces. They do a poor job, probably because of low securities-commissions budgets and shockingly low expertise within. An Enquiries Officer I spoke to at the Ontario Securities Commission did not appear to understand the word "expertise," when I asked what his expertise was.
It's time for major changes in our oversight systems and regulations.

Don Johnson is a retired journalist living in Victoria, B.C.