By Tom Bradley

We painfully announced last week that we’re raising the fee on four of our funds (see Press Release). This post provides some background.

As our clients know, we have a unique and attractive fee structure. Our ‘One Simple Fee’ captures everything that we charge, including taxes - there are no additional administration fees or commissions. This structure means, however, that when there are changes to our operating costs, the firm either benefits when costs decline or is hurt when costs rise. In 2008, Steadyhand’s profit margins improved due to the decrease in GST, but during our 4½ year history it has mostly been a one-way street in the other direction. We were prepared for the ever increasing regulatory burden and other unforeseen costs, but the introduction of HST truly hammered us.

HST

The harmonized sales tax, which was introduced in Ontario and B.C. on July 1st, 2010, applies to mutual fund fees, just as GST does. The tax was easily passed on to the investors by most firms, because virtually all mutual funds are priced on a ‘plus taxes’ basis (When the audited numbers for 2011 come out, we’ll see the full impact of HST on fund MERs).

We decided not to adjust our fee scale in 2010 because there was too much uncertainty at the time. Because the tax is patently unfair to managed investment products (see HST Will Hurt Investors and Their Nest Eggs), we were hoping the government might provide some relief (NOT). Also, the always volatile political scene in B.C. was thrown for a loop when Premier Campbell and the opposition leader both resigned and former Premier Vander Zalm started a vigorous campaign against HST. From a bottom line point of view, it was expensive to wait and watch, but we felt it was prudent.

Since then, the political landscape in B.C. hasn’t cleared up much, but the citizens did vote to get rid of HST. The government is currently working on a plan to phase it out.

Options

At the end of the day, sticking to our existing fee scale was not an option. Steadyhand is designed to be a low margin firm, but not a ‘no margin’ firm. So in weighing our options, we considered four key factors – fairness, long-term cost effectiveness, simplicity and flexibility.

After working through all the issues, it essentially boiled down to two alternatives. One was to raise the fees (as we’ve announced) and the other was to create a new class of fund units to be used only by clients in HST provinces (in our five-province world, that means Ontario).

The fee increase option scored high on simplicity and costs. We wouldn’t have to make our fee schedule more complicated or incur additional costs related to custody, record keeping, communications and client service. The downside, however, is that while the impact is small, this option is not as equitable – clients in the non-HST provinces are helping pay for Ontario’s additional tax.

Setting up an additional class of units is something that is done all the time in the mutual fund industry. Most funds have multiple classes, each designed for a different distribution channel. Most funds also have much higher fees. For us, this would have been the fairest way to deal with HST. We would have shifted our Ontario clients into an ‘HST’ class, while our other clients stayed in the existing ‘A’ class. This option would have also given us more flexibility in the event that any of the other provinces went the HST route.

Tradeoffs

We agonized over this decision (many meetings over two years), but decided on the first option. The desire to keep our offering simple and the overall costs down carried the day. Obviously, the fairness issue weighs heavily on us, although it is hard to know where to draw the line. Every client has a different cost structure depending on their needs, complexity and location.

I should note that we will continue to absorb part of the HST impact. If we were to fully flow it through, the fee increases would have been higher.

It should also be noted that we’re not alone in going this way. There are only four firms that created an HST class of units, and in recognition of the added costs, only one firm did it for all their funds.