The cost of owning the average mutual fund

[AltaRed]

IMHO, the single biggest way to change the Canadian scene so that the 'lower fee' fund companies can make it (including US firms trying to make it in Canada) is to legislate/regulate a level playing field such that the peddlers...err financial advisors of mutual funds have nothing to gain or lose recommending one fund over the other.

Thus no upping trailer fees, bonuses, Tahiti freebies and all the other stuff that influences mutual fund salespeople today.

[uhoh]

Thus no upping trailer fees, bonuses, Tahiti freebies and all the other stuff that influences mutual fund salespeople today.

oh, for a moment I thought you were talking about pharmaceutical salespeople.

[Bylo Selhi]

oh, for a moment I thought you were talking about pharmaceutical salespeople.

Yabbut drug pushers don't owe any fiducuary duty to their customers.

[brucecohen]

Thus no upping trailer fees, bonuses, Tahiti freebies and all the other stuff that influences mutual fund salespeople today.

In fairness, the Tahiti freebies were outlawed years ago. Trailers at most companies are identical or very similar. Redemption-mired AIC has juiced up their payments, but I'm not aware that it has helped.

Putting all fund on an F-class basis or at least annually reporting fee deduction and disbursement in dollars and cents on the individual account statement would revolutionize the provision of financial advice.

[AltaRed]

In fairness, the Tahiti freebies were outlawed years ago. Trailers at most companies are identical or very similar. Redemption-mired AIC has juiced up their payments, but I'm not aware that it has helped.

Putting all fund on an F-class basis or at least annually reporting fee deduction and disbursement in dollars and cents on the individual account statement would revolutionize the provision of financial advice.

On your first point: If you say so (and I do agree with you about the end of the visible freebies), but a few people I know reasonably well on the inside say they are 'encouraged' by their own management to 'recommend' certain mutual fund products at certain times. I can't believe product push is only influenced as a result of the 'dog and pony' shows put on by the fund companies for the advisors.

On your second point, I couldn't agree more.

[brucecohen]

a few people I know reasonably well on the inside say they are 'encouraged' by their own management to 'recommend' certain mutual fund products at certain times.

Would that be the house's own proprietary funds?

BTW, there used to be a little fandangle in which fundcos made reps pay for trips by sending in cheques, but the cheques somehow never got cashed. That was back '97 when I was on the inside. I doubt it still goes on, but don't know.

[parvus]

bruce wrote:

In fairness, the Tahiti freebies were outlawed years ago. Trailers at most companies are identical or very similar. Redemption-mired AIC has juiced up their payments, but I'm not aware that it has helped.

Putting all funds on an F-class basis or at least annually reporting fee deduction and disbursement in dollars and cents on the individual account statement would revolutionize the provision of financial advice.

I'm not so sure, partly because I wonder what the true cost of management is, and partly, what the cost of marketing is. Not to mention who pays for servicing the account.

On GlobeAdvisor, I see Saxon has an MER of 1.87 across the board for equity funds. The management fee is 1.75. The trailer is 50 bps. Now I think they're a well-run shop.

Now compare Saxon Small Cap to Mawer New Canada. Similar mandate, different style. Mawer has an MER of 1.4, and a management fee of 1.2, with a 20 bps trailer. Unlike Saxon, they don't advertise. So is the manager compensation, research and account service 100 bps? Does Saxon incur 25 bps for advertising? (I use "advertising" rather than "marketing" here because both would have institutional mandates, and they have to market themselves for the "stickier" money.)

Here's Beutal Goodman Small Cap. MER is 1.38, management fee of 1.25 with a trailer of 25 bps. Again, they don't advertise (well, at least nothing I've ever seen). Is the cost for a Canadian management company 100 bps? I think I've chosen three quality Canadian shops here.

Finally, to try to compare apples, DFA's International Small Cap is at 50 bps management, plus 100 bps for the advisor. (Some of their other mandates have much lower management fees.) Is the cost of the manager (as opposed to the management company) then 30 to 50 bps, depending on the skill required to handle the mandate?

On the other hand, I recollect somewhere that Bill Miller is considered high cost in the U.S., at IIRC ~1.3? bps.

I do think Canadian fundcos, even absent advisors, face higher marketing costs, given the lack of AUM. Is it because they're being all things (BTW, were seg funds included in the comparison, or U.S. variable annuities?) to all people, instead of specializing in various equity or fixed income mandates?

I don't know. Even Francis Chou charges 1.74%, with 1.50% for management, and, while his AUM is small, he doesn't market either, but he suggests that regulatory costs (up to 13 prospectuses, semi-annual statements and annual reports) aren't going to lessen. On the other hand, the OSC is awash in fees from regulatory filings. So I'm not sure fee-based or fee-only will help very much, although I would endorse it. After all, you're dinged with a discount broker or a commision-based planner anyway.

A compulsory disclosure of manager fees, advertising and marketing costs (including sponsorship of professional sports teams or events or free opera), account servicing expenses, regulatory tithes, accounting payments, lawyer retainers and advisor compensation might help to induce competition, but I suspect that investors would rebel at having to pay the additional cost to have their own investment costs properly disclosed.

Added: corrected some typos.

[AltaRed]

Would that be the house's own proprietary funds?

No

[DanH]

Sorry, Dan, I've been away. While I agree that the formula allows both front and back loads to be added in when calculating cost, there is no evidence that the authors ever set both the second and third terms in the sum to non-zero values. Unless you can demonstrate that their data set includes Canadian funds where they did this, you can't claim - or even imagine - that they have double counted.

It's not just the formula but the text preceding the introduction of the formula. The authors wrote (with emphasis added):

Our measure of total shareholder charges (TSC) includes the expense ratio plus annualized loads. Because loads are paid when entering and exiting the fund, it is necessary to divide these loads over the investor's holding period. We assume a five-year holding period in our analysis. This also allows us to compute the back-end load, because these loads often decline as the holding period increases. To do this, we study, for each fund, the schedule of loads and obtain the load paid by an investor with a five-year holding period.

It's just not clear at all what they're doing but based on what's in their paper, they use both. The authors have now circulated supplemental notes on their paper to address some concerns, like those I've talked about. And even there they don't clearly say what they do with respect to TSC.

P.S. Suppose you were the author of the paper. How would you rewrite that formula to take into account that some funds are front loaded and others are back loaded?

Make it clear and write two formulas. Or state conditions that apply to the main formula. I don't see what's so hard about this or why the lack of clarity in this paper is being excused. But maybe it's just me.

Okay, so Fido sells what amounts to a DSC version of its Japan fund in the US and it has expenses comparable to the Canadian version. So, in the US, Fido has made a business decision to sell both a DSC version and a no-load version and the result in assets (figures from M* today) is

Fido Japan (no load) $1,765MM
Fido Japan (all loaded versions together, including the C) $159MM

i.e. the load versions have 8% of that market.

In Canada, Fido's business decision is that all versions, loaded or not, are available only through high cost distribution channels. Why shouldn't Fido Canada wear that black eye?

Yes, it's their business decision to sell only through advisors. My point is that in some countries - like the U.S. - significant shareholder costs are being ignored while in Canada, they are more fully included. In other words, how do we know how much of the cheapest version of Fidelity's U.S. sold Japan funds (FJPNX) is held by DIY investors and advised investors paying additional fees to advisors?

In the context of quantifying total shareholder costs, that's a very relevant question in my opinion.

Plus, because the authors don't actually have data on the precise amounts of the sales loads in Canada and assume a holding period that is 25% shorter than actual holding periods; I'm not sure why the notion that fund unitholders are paying 4-5% per year for Canadian funds is being so widely accepted without much scrutiny.

As for my view in general, I am all for allowing DIY investors to buy F class funds. It makes no sense to me to pay for advice that is neither requested nor received.

I'm no academic and have never been published in any juried journal. However, this study reminds me of the saying "biting off more than you can chew". If the goal is to give a true and reasonably accurate picture of what investors actually pay for mutual funds, then it seems to me that a lot more work has to be done to accumulate data outside of what's available from Morningstar and Lipper databases.

Without this crucial information, I can't see how their research can truly be complete. Or, isolate one type of investor - i.e. DIY or advice seekers. But if they seek to quantify total costs for all investors, I suspect the data needed is much bigger than the huge database these researchers have already compiled.

[AltaRed]

Yes, it's their business decision to sell only through advisors. My point is that in some countries - like the U.S. - significant shareholder costs are being ignored while in Canada, they are more fully included. In other words, how do we know how much of the cheapest version of Fidelity's U.S. sold Japan funds (FJPNX) is held by DIY investors and advised investors paying additional fees to advisors?

In the context of quantifying total shareholder costs, that's a very relevant question in my opinion.

Would agree the question is relevant and without real data, we can only speculate. However, from the various assignments I have had in the USA, and spending a number of years gleaning US boards, I believe we would find a significant portion of the 'cheap' versions are held by DIY investors without paying advisors.

My reasoning is that a large part of the retail wealth in the market is held by employees with 401(k)s, IRAs and EPSPs in companies that have negotiated very low fees with their providers, be it Vanguard, Fidelity, Smith Barney, Merrill Lynch, etc. No loads ARE the expectation by the people I have been associated with. What the megarich do is another question but I would imagine they use professional money managers....not unlike what I expect their counterparts do north of the 49th.

[The Wealthy Boomer]

I comment on Daw's piece on IFIC's coming response in today's blog. When i posted it I hadn't read Karen's comment here but predicted IFIC will ultimately choose not to respond. Interesting that Karen tells us here that they never responded to her article and that "I think they preferred to sweep it under the carpet," is the way she puts it.

[Norbert Schlenker]

...In response to feedback by Canadian commentators, professors Ajay Khorana, Henri Servaes and Peter Tufano are circulating two pages of explanatory notes on Canadian fund data.

They clarify the study was not of the Canadian fund industry per se "but rather includes Canada in a sample of 18 developed countries. We took as much care as possible to make sure that all of our data was consistent ... the source of our Canadian data is Morningstar Canada."

The notes appear to dash any hopes the industry may harbour that the final version of the report might make Canadian fees look less egregiously high.

Because the actual level of various types of sales charges are not always included in Morningstar data, the report's authors "suspect that our failure to measure Canadian fund sales charges could underestimate fees in Canada."

The profs also quash the argument they might have "double counted" front and rear load sales charges. "We used a similar methodology and a similar holding period across all countries."

They also confirm the report does not include "seg" funds, which are a type of guaranteed mutual fund sold by life insurance firms. Management Expense Ratios (MERs) on Canada's segregated funds tend to be notoriously on the high side. So here, too, the study actually errs on the side of understating Canadian MERs, rather than overstating them as the industry would prefer the public believed.

Next, the profs tackle the objection their calculations include payment for "advice" in Canada. As we noted here in August, a big reason Canadian MERs are so high is that advisors receive annual "trailer" fees of 0.5% to 1% (or even 1.15% at certain bank no-load fund outfits).

The professors say they did factor in trailers but did the same elsewhere. "In the U.S. 12b-1 fees and loads are used to compensate brokers for providing advice. We feel that our comparisons are therefore appropriate from country to country."

Here again, far from overstating Canadian MERs, the methodology may have allowed Canada's fund industry to catch a break.

The professors note that where consumers pay wrap fees or pay fees directly to financial advisors, "we cannot observe them and therefore they are not included in our analysis."

They then make the comical (to me, at least) suggestion that "if Canadians pay more for advice, one would expect they would experience greater performance or satisfaction, which we do not study in our research."
...

Chevreau, FP Investing

[DanH]

Are Canadian fees excessive?

A preliminary research paper, titled Mutual Fund Fees Around the World co-authored by U.S. and British academics, is causing quite a ruckus. The draft paper concludes, among other things, that Canadian mutual funds are by far the most expensive in the developed world. Journalists are salivating over the paper, which has caused much trepidation in the Canadian fund industry. No doubt, Canadian fees are high. But, as usual, the devil is in the details.

...

I'm puzzled by the amount of the annualized load calculated by the researchers. The draft paper shows annualized loads as 198 basis points annually for Canadian funds. I inferred this figure from the difference between the 2.68% average total expense ratio and the 4.66% average total shareholder cost figures. Assuming a five-year holding period, that's equal to a total sales charge of about 10%. That exceeds any front end or deferred sales charge. I figure a 10% sales charge is only possible if both front and deferred loads are added together for each fund and assuming a fairly punitive DSC schedule. In practice, only one of front or deferred load applies to any single fund transaction - not both.

[Bylo Selhi]

Activist raises tough questions on fund fees

A debate over high mutual fund fees continues to rage, with analysts and investor advocates demanding more information...

Windsor analyst Dan Hallett is critical of the authors' figures...

But investor advocate Ken Kivenko argues the fee differential should be a matter of public concern. An industry association for mutual fund companies has promised to respond to the controversy over fund fees by the end of the month. So Kivenko has jumped on the opportunity to ask some pointed questions. Kivenko's questions will give other investors something to think about, even if the Investment Funds Institute of Canada chooses not to respond:

- Why can't do-it-yourself investors buy F-class funds, which are cheaper because managers don't pay annual trailer fees to salespersons?...

- Why are management expenses not reduced by a prescribed formula as assets rise in value within a fund? Are there no economies of scale as funds grow?...

- Why do managers of index-tracking funds charge such high management and sales charges compared with U.S. funds and exchange-traded index funds?

- Why can't Canadians have access to low-cost American funds, considering the North American free-trade agreement?

[Bylo Selhi]

And Jon's column today also appears to be on point but it's only available to subscribers. Can someone post it here.

[The Wealthy Boomer]

I believe Norbert did post a long excerpt upthread. I can't do anything about "locked" stories but note that the piece is being emailed around the country, along with Jim Daw's follow-up. As I note in today's blog version, it's also been picked up by Investment Executive and may also have been crossed over to a U.S. investment magazine.

For those who don't know, the blog is at www.nationalpost.com/chevreau

[yielder]

For those who don't know, the blog is at www.nationalpost.com/chevreau

And the Permalink to the blog entry is http://www.canada.com/nationalpost/news ... ?post=4327

[CA (can't add)]

What are the chances that any of the individual fund companies will respond rather than the IFIC? What about the fund distributors?

[tidal]

As Jon notes in his two most recent blog entries "And our consumers? They’ll continue to be chumps, except for the minority that insists on low-cost investments." and (regarding IFIC) "My bet is they’ll opt to forget all about it. Their historic response to books and other sources of criticism of the industry has been simply to ignore it and hope the public doesn’t notice too much."

Unfortunately, I think that remains the state of affairs. Until you get either or both of:
(1) improved governance (which includes the "buy-side") of investment products; and
(2) the introduction of the basics of finance and financial planning as required curriculum at the secondary school level (I am not talking about MPT or that stuff; just issues like compounding interest and the impact of costs) - so that they have all heard and have some basis to comprehend the gobbledy-gook about "outperformance" and "positioning your portfolio to deal with Avian flu" and "having a little fun with this part of the portfolio" that is foisted on them by advisors...

As Keith Ambachtscheer said here:

A fundamental tenet of micro-economic theory is that the interplay of buyers and sellers in free markets matches the demand for and supply of goods and services in the 'right' amounts, at the 'right' prices. Consequently, everyone is better off. However, there is an important (but often overlooked) caveat to the tenet. It is that the buyers and sellers have equal knowledge about the nature and quality of the good or service being bought and sold. When this assumption does not hold, all bets are off. ....

What if buyers underestimate the probability they may be buying a lemon? Then they will pay too much for too little. We believe this latter situation continues to reflect the reality of the market for investment management and research services. Specifically, the 'buy-side' has historically overestimated the value active investment management services can deliver, on average. Thus they too have paid too much for too little, on average.

He then goes on to discuss opportunities for better governance, buy-side co-operatives (he continues to be big on this...)...

Anyway, the point is that as long as this informational asymmetry persists, not much is going to change. Articles like Jon's, studies like Tufano et al's, books like Swensen's, are not likely going to be able to cope with the juggernaut taking the other position, namely the investment industry and 99% of the financial media. You will only get the consumer's attention if you fundamentally change the playing field, and that is not going to emerge from within the industry.

(By the way, speaking of Tufano - did anyone see his study from earlier this year? Mutual fund co's, in the US at least, when calculating their daily NAV's use today's securities prices, but yesterday's quantities!!!! Yikes!!!! Strategies; uh-oh. Something else is stale at mutual funds:Mark Hulbert )

[Bylo Selhi]

it's also been picked up by Investment Executive

For completeness, the Investment Executive article: Do Canadians pay the highest mutual fund fees in the world?

[DanH]

A show of hands...

Have you ever been charged front or back end load of 9%, 10%, or 13% on your mutual funds (not including the MER)?

Anybody?

Oh right, let's not let measely details get in the way of a good cause. Carry on...

[tidal]

A show of hands...

Have you ever been charged front or back end load of 9%, 10%, or 13% on your mutual funds (not including the MER)?

Anybody?

Oh right, let's not let measely details get in the way of a good cause. Carry on...

Is that what they are contending is normal practice? Then, yeah, it is a bit of a stretch...

But to answer your question - yes, I certainly have seen charges this high. I believe that these kinds of fees were effectively discouraged after the Stromberg report came out, but I recall seeing advisors charge the top 9% DSC fee on BPI funds, and I think at one (long ago) time the Trimark Fund was only available with a 9% front end load... Those incentives were in place for one reason only - they work, i.e. advisors sold those funds.

At least some bank-owned firms were paying their in-house advisors 2x the trailer fee for selling in-house funds until just a year or two ago, when the settlement for mutual fund trading abuses was the hot potato... They have since dropped those trailers to "competitive" levels... But again, those incentives "worked" - typically the top-selling funds were the in-house funds with the highest trailers...

[Bylo Selhi]

Have you ever been charged front or back end load of 9%...on your mutual funds (not including the MER)?

IIRC until the early 1990s, 9% was the standard FE load.

According to the 1992 Templeton Growth prospectus they charged an MER of ~93bp back then. The FE load was 6% (but buried in the fine print, the truth: "6.38% of the net amount invested by you".) There was also a DSC option for which "the amount of the sales commission is determined by the Principal Distributor at its sole discretion." The early redemption fee was 6%, declining by 50bp per year. The trailer at that time was 25bp for purchases before Aug92 and 50bp for purchases thereafter. (Presumably that's why the prospectus was reissued.)

Today the MER on TGF is 235bp. Subtract 50bp for the DSC amortization and you've got 185bp. Subtract up to another 25bp to equalize for the now higher 50bp trailer and you're at 160 to 185bp for an apples-to-apples comparison.

So why did the MER go up by 72% to 99% despite the economies of scale that supposedly comes from assets that multiplied in size?

[DanH]

Perhaps I didn't make myself clear. Since this draft paper used data from 2002 (not from more than a decade ago), I'll rephrase my question to you all...

A show of hands...

In any year near 2002, have you been charged front or back end load of 9%, 10%, or 13% on your mutual funds (not including the MER)?

Is that what they are contending is normal practice?

Yes. Seems nobody is paying much attention to the 1.98% annualized sales loads calculated in this paper - both the Feb 2006 and May 2006 drafts. The figures range from 1.85% per year for bond funds and 2.60% per year for balanced funds. That's over a five year period, hence the total % figures above. And hence the collision of my jaw with the floor.

[NormR]

From the paper (Draft version May 7, 2006 -- data from ~ year end 2002) Table 2,

Total Shareholder Cost (TSC) = TER + initial load / 5 + back-end load at five years/ 5.

Thus, (TSC-TER)*5 = initial load + back-end load (at 5 years) = Total Load


Panel A for Canada Shows (TSC-TER & Total Load are my additions)...

Code: Select all

Fund Type     TER   TSC  TSC-TER  Total Load
Balanced      2.93  5.53 2.60     13.00%
Bond          2.25  4.10 1.85      9.25%
Equity        2.87  4.93 2.06     10.30%
Money Market  1.64   -    ?         ?
Full Sample   2.68  4.66 1.98      9.90% 


So, as of the end of 2002 the authors claim that the load on the average Canadian fund (including no-load funds) was 9.90%. How shall I put this kindly, an average load of 9.90% in 2002 is at significant variance from reality and puts into question the results derived from using it.

[Ed]I note that in a supplementary letter the authors say that "3. Because Morningstar Canada generally does not publish the size of these charges in its database, we could not calculate TSCs for many Canadian funds. This means that the TSC category of fees may be less representative than MERs and TERs. In general, we suspect that our failure to measure Canadian fund sales charges could underestimate fees in Canada. " So, they expect that the TSCs are underestimates which would imply even larger average total loads. Nonetheless, it does mean that <TSC> is only approximately equal to <TER> + <Loads>/5 and that the actual loads could be smaller.[/Ed]