The cost of owning the average mutual fund

[yielder]

Yabut.....Canadians can already buy Vanguard ETFs,

Yabbut it's the active funds that will drive down Canadian active fund MERs.

[The Wealthy Boomer]

Rest easy: IFIC assures us that most Canadians are "comfortable" with mutual fund MERs. As Ken Kivenko notes in a column on this in today's FP, "a fee is a tax on people who don't understand."

[Bylo Selhi]

Cost of investing does matter

The incontrovertible fact is that costs matter. And Canadians who invest in the high-cost mutual funds offered by the Canadian financial services industry are unknowingly giving up an exorbitant amount of the long-term capital they would otherwise be accumulating while needlessly exposing themselves (based on their actual return) to the market risk of loss of capital. This is unconscionable. It is a systemic and societal problem that legislators need to address without delay if Canada is to avoid the huge social costs, high taxation and lack of productivity that will flow from the need to care for the large segment of its population that will not have sufficient savings to provide for their own financial well-being.

It is beyond belief that the financial services industry has not taken steps to address the problem of ever-increasing costs and that it stonewalls regulatory and self-regulatory initiatives to do so. The arguments that competitive market forces are sufficient to regulate the matter and that the marketplace is efficient simply do not hold water in the face of the investing public’s lack of knowledge and awareness of what is on offer by the financial services industry. It is a classic case of informational asymmetry, in which the sellers know more than the buyers.

In addition, there is a lack of equal bargaining power. The situation is aggravated by an industry that preys upon its customers by encouraging them to rely on them for strategies to financial well-being. Charging what the market will bear in these circumstances is akin to shooting fish in a barrel.

What will it take to end this shameful situation? One solution would be through the courts finding that these high-cost products are not suitable investments. Another would be for Canadians to realize that these high-cost investments are not a prudent way to accumulate savings and to stop investing in them. Another would be for legislators to act.

Yet another would be for legislators, regulators and the industry to remedy the factors identified in the Khorana study as contributing to the high costs — the quality of the legal system in general and investor protection in the fund industry in particular. For example, the study finds that fees are lower in countries in which custodians are required to be independent (a requirement that does not exist in Canada), foreign competition is allowed and there is a less-concentrated banking sector or one in which banks are not allowed to enter the securities business. Greater investor protection is seen as relating to lower fees.

Meanwhile, those who ignore the study’s findings may find themselves in the shoes of the farmer who killed the goose that laid his golden eggs.

[ockham]

Friends bought a UL policy some years ago. Reason was to get non-RRSP investment returns into a tax sheltered environment. What they didn't know, and have recently discovered, is that the average MER of the funds available for investment inside the policy is ~3.25%. At that level, there is no reasonable prospect of after tax returns inside the policy being better than after tax returns outside it. Unconscionable?!

[DIYCitizen]

What will it take to end this shameful situation?

Legislation would not be a good thing. The less government involvement the better, since they would go into cost overruns (as usual). It is not clear to me what the legal authority of the courts would be if they find the high costs as not being suitable. Perhaps a case could be made to open up the availability of F-class funds to all investors, but, again, what authority do they have to tell a company how to run a business. Sounds pretty left wing to me. Anyone?

Unfortunately the only way to make the "situation" change is to educate the investors through such avenues as this forum, newpapers, and columns like Ms. Stromberg's. Hopefully in a few decades they will see the benefit, if they're still around. For the rest of the "enlightened" ones, we will carry on doing better than the average Joe or Sally.

[boib22]

I assume an actively managed mutual fund trades in and out of securities. Is the trading cost included in the reported MERs.

I ask this as there is a management fee, trailer fees for the sales force, and administration fees charged as a percentage of assets. Trading cost/brokerage fees should vary from fund to fund depending on how active the manager is.

Is this expense reported and where.

[YogiBear]

I assume an actively managed mutual fund trades in and out of securities. Is the trading cost included in the reported MERs.

No. Transaction costs are capitalized, while the MER measures current expenses charged to the fund.

I ask this as there is a management fee, trailer fees for the sales force, and administration fees charged as a percentage of assets. Trading cost/brokerage fees should vary from fund to fund depending on how active the manager is.

Is this expense reported and where.

There is a TER- Trading Expense Ratio- that is reported in the semi-annual Management Report of Fund Performance (or some similar name). It represents commissions and other transaction costs as a percentage of net assets.

For brokerage commissions in absolute dollar terms over a specified time period, look in the notes to the mutual fund financial statements (always read the notes).

[boib22]

There is a TER- Trading Expense Ratio- that is reported in the semi-annual Management Report of Fund Performance (or some similar name). It represents commissions and other transaction costs as a percentage of net assets.

For brokerage commissions in absolute dollar terms over a specified time period, look in the notes to the mutual fund financial statements (always read the notes).

Thanks Yogi

Does this hold true for ETFs?

[kcowan]

..Unfortunately the only way to make the "situation" change is to educate the investors through such avenues as this forum, newpapers, and columns like Ms. Stromberg's. Hopefully in a few decades they will see the benefit, if they're still around. For the rest of the "enlightened" ones, we will carry on doing better than the average Joe or Sally.

How about making FTA apply to trading? Let us all get the benefit of the US market going both ways. We need to argue that trading is different than banking to get around the Bank Act?

[YogiBear]

Does this hold true for ETFs?

You can check for yourself by looking through the documents listed at the "iShares Document Library" I linked to on the other thread you started ("ETF Annual Reports"). A friendly hint- look in the documents with the same name as those I referred to upthread ...

[parvus]

ockham wrote:

Friends bought a UL policy some years ago. Reason was to get non-RRSP investment returns into a tax sheltered environment. What they didn't know, and have recently discovered, is that the average MER of the funds available for investment inside the policy is ~3.25%. At that level, there is no reasonable prospect of after tax returns inside the policy being better than after tax returns outside it. Unconscionable?!

I doubt the actual MERs on the underlying funds are that high. But there are insurance charges that could well bump up the MER. UL, IMO, is not generally a useful tax-sheltering solution for most retail investors, though it might work with a straight bond investment (since interest is sheltered).

That assumes no debt, a paid-down mortgage and a topped-up RSP as well as an open investment account designed to capture tax-efficient capital gains. (A lot of the UL marketing hype was generated when capital gains were taxed at 75%; I wonder if life agents have updated their sales pitches to reflect a) less exuberant markets and b) more modest capital gains taxes. As it is, the securities regulators are wondering whether life agents should be allowed to sell investment-type products without at least a cursory acquaintance with how capital markets work — and whether the fees are worth it for the protection from capital market downturns offered.)

Absent significant illiquid estate liabilities or other potentially catastrophic potentialities (and thus, a real insurance need), it is generally an expensive way to get someone else (the lifeco) to pay taxes for you on death (through those insurance charges I mentioned— the lifecos aren't doing this for free — plus federal and provincial premium taxes, just to make sure the lifecos don't get away with excess profits). But our resident life insurance guru, Beaverlodge, may disagree with me.

In response to your friends' situation, however, I wish more clients and their advisors would consider the consequences before buying the policy on the basis of some tax pitch. I've come across a few tax-pitchers, myself, trying to sell to friends and relatives. What they forget to mention is that it is more profitable to the client to unwind a UL policy through death than by surrender charges that cover the lifecos' actuarial liabilities for letting a poorly trained agent keep his commission — but whack the former policy-holder with tax liabilities similar to that of a collapsed RRSP.

Keep it simple. Look at life insurance when you need it, not when your agent wants to sell it.

[Bylo Selhi]

Industry must address high costs

September has come and gone without the Investment Funds Institute of Canada making its promised “full public response” to the controversial study, Mutual Fund Fees Around the World, by Ajay Khorana, Henri Servaes and Peter Tufano, professors respectively from the Georgia Institute of Technology, the London Business School and the Harvard Business School. The study found that, after adjusting for fund type, fund size, complex size and other variables, Canada charges the highest fees in the world, by far. The factors identified as contributing to the high cost of mutual funds are the quality of the legal system in general and investor protection in general. Greater investor protection is seen as relating to lower fees.

IFIC chairwoman Brenda Vince obliquely recognized these factors in her remarks at the IFIC annual conference, when she said the funds industry should not shy away from greater transparency, more competition and enhanced investor protection; and IFIC should encourage debate among members on issues that would enhance the industry’s competitiveness and long-term health.

Issues Vince singled out for debate are an expanded range of pricing options for mutual funds, more transparency in pricing and the value of advice and advisors.

If Vince’s objectives are going to be met, it will take more than just debate among IFIC members or the funds industry. It will have to involve governments, regulators and the investing public.

The reality is that high costs are eroding Canadians’ ability to accumulate sufficient assets to provide for their financial well-being. The competitive forces that normally work to produce the value proposition are simply not there. There are many reasons why.

If we are going to give credence to the much discussed and laudable goals of enhancing investor protection, fostering competition, increasing productivity and enhancing the financial and economic well-being of Canadians, we will have to address the factors that stand in the way.

The core issue to address is Canadians’ general lack of knowledge and awareness of financial and economic matters, and of cause and effect. This is aggravated by the knowledge gap between sellers/providers of financial products and advice and their customers/clients, as well as the unequal bargaining power of the customers/clients. Conventional remedies for this sorry state of affairs are education and disclosure. Governments, regulators and the funds industry have failed Canadians on both accounts.

Take disclosure. The lack of transparency of fees and charges, and the impact these fees and charges have on investors’ long-term total return is unconscionable. Disclosure of fee impact risk on long-term capital is crucial to levelling the playing field for investors. The delivery of disclosure materials to investors is also crucial.

Another factor leading to capital-eroding high costs is the regulatory decision to allow distribution costs to be charged to mutual funds. In addition to embedded sales commissions (trailer fees), this has led to the full cost of prospectuses and annual reports — including legal fees, printing and distribution costs — being charged to the mutual fund. These distribution costs represent a conflict between the manager (who is seeking new unitholders) and the fund’s existing unitholders. This conflict used to be kept in check by the regulatory requirement (no longer in effect) that a fund’s fees and charges could not exceed 1% of its net asset value.

Another factor undermining the discipline on fund managers to keep operating costs of funds under control is managers’ adoption of fee structures permitting them to add operating costs to the costs paid by unitholders. Many operating costs charged to funds are for services provided by related parties to managers without having been tendered for competitive bids. Fund operating costs will soon include costs of the independent review committees that will monitor managers’ conflicts of interest.

There are many other factors behind managers’ conflicts of interest and the value proposition of mutual funds. They need to be addressed from the unitholders’ perspective. Unitholders need a seat at the table.

[my emphasis]

BTW when did we have a "regulatory requirement (no longer in effect) that a fund’s fees and charges could not exceed 1% of its net asset value"? Why (and how) did we lose it?

[WishingWealth]

We're No. 1: Why do Canadians pay the world's highest mutual fund fees? Doug Steiner in the G&M.

It's now pretty much official: Canadians pay the world's highest mutual fund fees. A draft paper released this past summer confirmed that Canada is No. 1 by a huge margin. The paper was written by three academics--Ajay Khorana of Georgia Institute of Technology; Henri Servaes, from London Business School; and Peter Tu-fano of Harvard Business School--and it's one of the most exhaustive studies ever done on global mutual fund fees.

The trio examined 46,799 funds offered in 18 countries. Researchers calculated an annual "total shareholder cost" (TSC) for each fund by adding the yearly fees charged by the fund (known in Canada as the management expense ratio, or MER) and any one-time commission paid to the seller of the fund. The commission was divided by an assumed holding period of five years.

The average TSC for funds sold in Canada was 4.7%, far ahead of second-ranked Ireland, at 2.7%, and the overall average of 1.9%. Some Canadian fund analysts questioned the percentages in the study, but even they agreed that Canadian fees are relatively high. You can almost see the authors of the study raising their eyebrows at our fees in a section of the paper titled "A tale of two North American neighbours."
...

WW

There were a few threads on the price differential of books and cars between Canada and the US. I also get peeved when comparing the prices of electonic 'toys'.
Using the author's famous words: What gives?

[NormR]

We're No. 1: Why do Canadians pay the world's highest mutual fund fees? Doug Steiner in the G&M.

Ah, the ~5% TSC (= ~10% loads) makes yet another appearance. Followed by the apples to oranges example of the Canadian vs U.S. fund used in the paper. Another low-fee advocate snared by bad numbers.

[kcowan]

...There were a few threads on the price differential of books and cars between Canada and the US. I also get peeved when comparing the prices of electonic 'toys'.
Using the author's famous words: What gives?

In a prior life, I was on the hotseat to explain why the Canadian market did not produce 10% of the sales of the US but was dragging along at 5%. We were able to show that the higher taxation reduced the takehome pay in half. There were lots of competing demands for this takehome pay. Because of the dynamics of supply and demand, we had to charge more per unit to cover the lower volumes and compensate for lack of ecomonies of scale. Of course this lead to a gray market and it was before the option of eBay.

I often establish the eBay selling price then go to a small local retailer and offer the same landed cost with some success.

The only solution to the MERs is to open the border. We are in the minority so will never have enough clout to change the behaviour.

[Bylo Selhi]

Another low-fee advocate snared by bad numbers.

Steiner qualified his assertion with "Some Canadian fund analysts questioned the percentages in the study, but even they agreed that Canadian fees are relatively high." Are you trying to suggest that Canadian mutual fund fees aren't "relatively high" in comparison with the other countries studied?

[NormR]

Another low-fee advocate snared by bad numbers.

Steiner qualified his assertion with "Some Canadian fund analysts questioned the percentages in the study, but even they agreed that Canadian fees are relatively high." Are you trying to suggest that Canadian mutual fund fees aren't "relatively high" in comparison with the other countries studied?

Are you saying that you won't complain about an article in the public press that said "Mutual fund fees in Canada are the lowest in the world by far. Some fund analysts questioned the percentages, but even they agree that fund fees are a small fraction of one's investment"?

Ah well, it goes well with the "Your kids will be horribly mutilated/poisoned/killed. Save your kids today by watching our news cast at 6 & 11." Tune and you'll learn a few animal husbandry tips.

[DanH]

Another low-fee advocate snared by bad numbers.

Steiner qualified his assertion with "Some Canadian fund analysts questioned the percentages in the study, but even they agreed that Canadian fees are relatively high."

Steiner's use of the 4.7% implies a general agreement with it - otherwise why quote it?

Are you trying to suggest that Canadian mutual fund fees aren't "relatively high" in comparison with the other countries studied?

The authors missed so many items specific to the Canadian market, how do we know they didn't miss at least as many for each of the other markets, many of which have less robust data available? Besides, for people who want to go it alone, there is a significant and growing universe of cheap product available.

Do we know what investors in those other countries have available to them? In other words, while our average fees are somewhere north of 2% we have products available to the general public that cost 0.5% and under. So, if another country with 1.5% have the same availability at the low end? The study doesn't tell us - nor does it intend to.

What's most telling in all of this is that I've challenged many people who have tossed out this 4.7% figure. NOT ONE has been able to justify it to me. NOT ONE. This begs the question: why do people keep using it?

[IdOp]

RBC mutual funds are trimming 15 bp off their MERs for 9 international equity funds.

RBC trims fees

Baby steps in the right direction, I guess. No word yet on how many basis points investor "comfortableness" will increase due to this change.

[tidal]

RBC mutual funds are trimming 15 bp off their MERs for 9 international equity funds.

RBC trims fees

Baby steps in the right direction, I guess. No word yet on how many basis points investor "comfortableness" will increase due to this change.

Meanwhile, Barclays Global Investors (BGI) (US) has filed a new prospectus with the SEC indicating that it will reduce the MER on virtually all of their single country fund etf's (EWC, EWJ, etc.)... Again, just by 4 to 5 bps per fund, but from a much lower starting MER... AND, what is perhaps more interesting is: Barclays' management agreement for many of its funds calls for a direct relationship between fees and assets levels, with fees falling as different fund families reach new milestone asset counts.

You can still do this cheaper and more diversified by using VPL, EFA, VWO, etc., but I think we may see these come down too...

[parvus]

tidal wrote:

Barclays' management agreement for many of its funds calls for a direct relationship between fees and assets levels, with fees falling as different fund families reach new milestone asset counts.

OTOH:

BGI collects annual management fees equal to 2 percent of assets under management for some of its dozens of hedge funds, the industry standard. Like most hedge funds, BGI then takes a cut of about 20 percent of any profits on those funds, according to a record of fees that BGI has filed in Ireland. BGI's U.S.-based ETFs, by contrast, charge average annual fees of 0.32 percent.

<snip>
Lately, BGI, originator of the index fund, has been pushing a new type of long/short strategy designed to mimic hedge fund investing at a fraction of the cost. These funds short the equivalent of 20-30 percent of their assets and employ a tool common to hedge funds: leverage. Money managers call these investments 120/20s or 130/30s, because they borrow the equivalent of 20-30 percent of the value of their assets to finance the short sales.

The funds aren't bona fide hedge funds, because they short on a limited basis and otherwise track an index such as the S&P 500. Fees for most 120/20s run closer to what index funds charge, about 0.6-0.9 percent of assets under management, according to Morgan Stanley.

All in all, an interesting read.

[investormac]

A Toronto Star article recently discussed the possibility of Canadians being allowed to buy U.S. domiciled mutual funds, which would give Canadian-domiciled funds more competition. Does anyone know how this prohibition got started in the first place? What was the rationale, or was it simply a sop given to well-connected Paul Desmarais and other owners of Canadian financial companies? And why wasn’t it included in the Free Trade Act?

[brucecohen]

A Toronto Star article recently discussed the possibility of Canadians being allowed to buy U.S. domiciled mutual funds, which would give Canadian-domiciled funds more competition. Does anyone know how this prohibition got started in the first place? What was the rationale, or was it simply a sop given to well-connected Paul Desmarais and other owners of Canadian financial companies? And why wasn’t it included in the Free Trade Act?

I'm only guessing but it might go back to Bernie Cornfeld and the Investors Overseas Fund saga in which he used funds incorporated in Canada to cheat, rob and rape investors in the US and elsewhere Since then, I guess, regulators around the world have likely moved to limit their markets to domestically domiciled funds in order to be able to police the arena. I don't know if any other country allows the offering of mutual funds incorporated elsewhere -- that is, funds designed for mass-market sale.

[Nemo2]

I'm only guessing but it might go back to Bernie Cornfeld and the Investors Overseas Fund saga

Wow..a, (sour tasting), 'Trip Down Memory Lane'.......damn near 40 years ago, when I could ill afford it, I lost about $200 to Bernie.......put me off investing for quite a while.

[YogiBear]

I don't know if any other country allows the offering of mutual funds incorporated elsewhere -- that is, funds designed for mass-market sale.

A technicality, perhaps, but Dublin-domiciled iShares are listed on a number of European exchanges (located in EU member states, of course), as well as in Switzerland (on the SWX), which is not a European Union member but does have a number of bilateral trade and reciprocity agreements with the EU- see here for an example.