IFC Mutual Fund Fees and Services 4 — Questions and Answers
Question 1: An advisor recommends a DSC fund to a client who may need access to their invested capital within one year. From a suitability standpoint, this recommendation is:
- Appropriate because the fund offers daily liquidity
- Potentially unsuitable because DSC fees could apply on early redemption (Correct answer)
- Acceptable if the client signs a waiver acknowledging the risks
- Appropriate as long as the fund is diversified
Correct answer: Potentially unsuitable because DSC fees could apply on early redemption
Recommending a DSC fund to a client with a short time horizon is potentially unsuitable because early redemption would trigger significant DSC fees.
Question 2: The trading expense ratio (TER) of a mutual fund primarily reflects:
- The annual management fee paid to the portfolio manager
- Brokerage commissions and other trading costs incurred by the fund (Correct answer)
- The deferred sales charge schedule applied on redemptions
- The trailer fee paid to the dealer from the fund's assets
Correct answer: Brokerage commissions and other trading costs incurred by the fund
The TER captures brokerage commissions and other portfolio transaction costs, which are reported separately from the MER to give investors a complete cost picture.
Question 3: A client enrolled in a systematic withdrawal plan (SWP) receives fixed monthly payments from their mutual fund. What risk must the advisor highlight?
- The plan requires the client to hold at least five different funds
- Withdrawals may exceed investment returns, gradually depleting capital (Correct answer)
- SWPs are only available under no-load purchase options
- The plan automatically converts to a GIC after five years
Correct answer: Withdrawals may exceed investment returns, gradually depleting capital
If market returns are lower than the withdrawal rate, the client's capital will erode over time, which is a key risk advisors must disclose for SWPs.
Question 4: Under client-focused reforms (CFRs) in Canada, how must advisors treat embedded commissions such as trailer fees?
- They must rebate all trailer fees directly to the client
- They must disclose trailer fees and ensure recommendations are in the client's best interest (Correct answer)
- Trailer fees are banned and replaced with direct fee billing only
- Advisors may keep trailer fees without disclosure if the fund is no-load
Correct answer: They must disclose trailer fees and ensure recommendations are in the client's best interest
CFRs require advisors to disclose all compensation including trailers and prioritize client interests, though trailers themselves have not been banned in Canada.
Question 5: A client switches $50,000 from a DSC fund in Fund Company A to a fund in Fund Company B. What is the most likely consequence?
- The DSC clock resets with no fee charged as this is a tax-sheltered account
- DSC fees may be triggered because the switch is between different fund families (Correct answer)
- The fund company must match the lowest available MER in the industry
- No fees apply since Fund Facts regulations prohibit inter-company switch fees
Correct answer: DSC fees may be triggered because the switch is between different fund families
Switching to a different fund family is treated as a redemption from the original fund, which typically triggers DSC fees if the holding period schedule has not been completed.
Question 6: Which of the following is a key benefit of the 'F-class' mutual fund series?
- F-class funds charge a higher MER to cover full advisor compensation
- F-class funds have a lower MER because trailer fees are stripped out, suited for fee-based accounts (Correct answer)
- F-class funds are exclusively available for RRSP and TFSA accounts
- F-class funds guarantee a fixed return regardless of market performance
Correct answer: F-class funds have a lower MER because trailer fees are stripped out, suited for fee-based accounts
F-class (fee-based) funds do not include trailer commissions in their MER, so they are priced lower and are appropriate for fee-based advisory accounts where the client pays the advisor directly.
Question 7: A mutual fund's prospectus states a maximum front-end load of 5%. A client negotiates a 2% front-end load with their advisor. Which statement is correct?
- The negotiated rate is not permitted; the stated maximum must be charged
- The client may pay any rate at or below the stated maximum, including 0% (Correct answer)
- A 2% front-end load must be disclosed to the fund company for regulatory approval
- Front-end loads cannot be negotiated and must equal the MER percentage
Correct answer: The client may pay any rate at or below the stated maximum, including 0%
Front-end loads can be negotiated downward from the stated maximum to as low as 0%, giving advisors and clients flexibility in determining the purchase commission.
IFC Mutual Fund Fees and Services 4
An advisor recommends a DSC fund to a client who may need access to their invested capital within one year.
From a suitability standpoint, this recommendation is: