This Management Practice Inc. (MPI) Bulletin summarizes the detailed findings of our first survey of Canadian Mutual Fund governance practices. This is based on a comprehensive review of the Annual Information Forms filed in the year 2000 by all Canadian Mutual Funds, together with confidential responses from the survey participants. The second edition of this survey for 2001 will also be based on AIFs and participant responses. It will be issued later this year.
Governance of mutual funds in Canada is a hodgepodge of oversight techniques that reflect differing provincial and federal tax, regulatory and legal requirements. In recent times some rationalization has occurred with a trend toward governance independent of the fund manager. This Bulletin explores this trend and summarizes the survey findings about compensation of independent trustees or directors.

Governance Functions

Canadian mutual funds take several forms. At the end of 2000, roughly 88% of all Canadian mutual funds are trusts, while 12% are structured in corporate form. However, in the past two years over half of new mutual funds have been in this corporate form or adopted a corporate form of governance.

In the course of our survey, we identified two concepts of fund governance:

Manager Governed. In these funds (typically trusts), governance is performed by the fund management company itself, a separate trust company (typically affiliated with the fund manager), the directors of the fund management company itself, or a group of senior employees of the fund manager (with the possible addition of some non-management trustees).

Investor Governed. In these funds (typically corporations) a board of directors, a majority of whom are independent of the fund manager, performs governance. The directors hire an investment manager to invest the assets of the corporation. They may also retain other service providers, such as a transfer agent, custodian and fund accountant, to accomplish additional functions. Some of these service providers may be affiliated with the fund manager. Some Canadian mutual fund trusts, while striving to preserve some of the tax and other advantages of the trust form, have instituted a Board of Advisors (of which a majority is independent of the fund manager) to fill the same role as the corporate form Board of Directors.
Stephen Erlichman, in his June 2000 report to the Canadian Securities Administrators (CSA) Making it Mutual: Aligning the Interests of Investors and Managers, recommends the corporate style board should the CSA decide to mandate one form of governance regime for the future. In an age when mutual fund managers are likely to be affiliated with multi-national corporations who require short-term earnings and ever more competitive returns for their investors, many industry experts feel that real and perceived conflicts of interest are best avoided by the use of a well-informed and independent board of directors.

The primary responsibility of a fund trustee or director is to safeguard the interests of the mutual fund investor. This implies a high standard of care and primary duty of loyalty to the investor. Both trustees and directors are obliged to enforce the terms of the fund documents, preside over ethical behavior and guard against the misuse of the unit holders' money.

One function, which does not currently lie with the directors of a Canadian mutual fund, and is specifically rejected in the Erlichman report, is the right to terminate the manager. In the United States, mutual fund directors not only have this authority (although they virtually never use it) but also the responsibility to annually negotiate the terms of the management contract. Based on our discussions, Canadian practice presumes that the investor buys a specific fund with an expectation that a particular fund manager will continue to invest the fund's assets and with full knowledge of the fee arrangements. Directors are not empowered to interfere with this presumption. Investors can sell their investment if the arrangements become unsatisfactory.

Compensation for Governance

The trustees of a "manager governed" trust typically receive no extra compensation for their oversight, as this is assumed to be part of the management fee. Indeed, not all directors of "investor governed" mutual funds are paid. We found that only about 60% receive separately identified compensation.

The median compensation for all fund directors (who receive compensation) was $11,375 per year. Directors of fund families with less than $500 million under management receive a median of $5,982 and directors responsible for more than $10 billion receive a median of $14,500. Directors of fund families with less than five funds receive a median of $4,000, those with between five and ten funds receive $12,000 and those responsible for more than ten funds receive $12,937.

These pay rates average about one third of the equivalent US mutual fund director compensation levels, however the Canadian director does not have the authority to hire and fire the investment manager and does not annually renegotiate the management contract.

Median Director Compensation in Cdn$

Assets less than $500 million $5,982
Assets of $500 to $10 billion $12,000
Assets of more than $10 billion $14,500
All funds

$11,375

Less than 5 funds $4,000
5 to 10 funds $12,000
More than 10 funds $12,937
All funds

$11,375

We also ran regression analyses to see how director fees relate to (a) the aggregate level of assets and (b) the number of funds governed. We found that the director of even the smallest fund group is predicted to receive $4,000 per year. Similarly, we found that a director of a $50 billion complex with 50 funds or over is predicted to earn a total of $25,000 per year, assuming a linear relationship between director compensation and fund size.
Additional information, including the separation of total compensation into retainer and per meeting fees, is available by participating in the detailed survey.