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DSCs on way out
Three reasons to reduce use of DSC funds

Investment Executive recently reported that the sales of deferred sales charge (DSC) funds account for roughly half of mutual fund sales - down from about three-quarters just a few years ago. There are a few industry developments that explain this trend. But there are also good reasons for advisors to use this commission structure less and less.

Double dipping

In the growth days of the fund industry, there was seemingly an endless run of new money flowing in. This was due in large part to a massive shift of money out of GICs and other low-interest-bearing holdings. By the late 1990s, this trend had pretty much run its course. Sure, new money kept flowing in, but proportionately, growth was slowing.

Presumably, the industry's flow of new clients had probably peaked, if not nearly dried up. There is always new money, but less of it because there are relatively few new investors in funds. Hence, once the original DSC schedules expire (which is starting to happen), even the strongest proponents of DSC funds would have a hard time reinvesting newly 'free' units in another 6 or 7 year schedule. Plus, another lump sum commission payment would be tough to justify.

I'm sure some advisors flip old DSC funds into new purchases, but in my experience such double dipping is rare.

Portfolio flexibility

Having restructured a number of ailing portfolios, I can tell you that DSC schedules do present a fairly serious portfolio constraint. Changing circumstances or fundamentals often require a shift in asset mix and in individual portfolio components. But attempting to do so while facing an exit fee presents considerable challenges.

This is likely one of the reasons that financial advisors often limit their repertoire to just a handful of large fund companies with lots of choice. Hence, an advisor who becomes disenamoured with - for instance - Mackenzie's Ivy Canadian can switch to Cundill Canadian Security or Universal Canadian Growth without any DSC fees.

However, one constraint presents another. Limiting choice only to the largest firms with the greatest breadth doesn't necessarily equate to the best quality (a subjective measure to be sure). But the DSC structure makes using great funds from small families (and those with limited alternatives) unfeasible.

Making use of the new low load structure allows advisors to be paid while not tying the client up for more than a couple of years. And then, the exit fees for early withdrawal are 2 percent instead of 6 percent. Straight front-end loads are also an option, which actually results in more money for the long-term-minded advisor anyway due to the higher trailer fee. Either way, the structure used to compensate advisors for their work should be the result of an interactive discussion with clients.

Manager turnover

Last week's departure of Bill Kanko from Trimark (the second time in a decade) drives home one of the most serious risks of using DSC funds. While I have no concerns about Trimark Fund and Trimark Select Growth, there are instances where the continuity of management becomes an issue. And if money was invested on a DSC schedule one day, and a significant manager change occurs shortly thereafter, you're out of luck.

DSC funds have their place. They allow smaller investors access to advice they'd otherwise not be able to afford. DSC funds may also be used in smaller proportion on larger accounts where lots of planning work is done up front. However, aside from those two scenarios, the justifiable applications of DSC funds today are few.

Placing client interests first may not be a get rich quick path, but it's certainly a key ingredient to building a solid practice of happy clients.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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