The cost of owning the average mutual fund

[Norbert Schlenker]

What justifies average annual fees of 2.5%+ on domestic equities?

[NormR]

What justifies average annual fees of 2.5%+ on domestic equities?

Sorry Norbert, you'll have to find someone else to argue for 2.5%+ fees.

[Norbert Schlenker]

I guess I don't understand your motive in criticizing the study or its authors then, Norm. Are you interested only in statistical accuracy but not in any lesson that might be drawn from the statistics once they are accurate?

[Bylo Selhi]

It seems to be far better to rely on one's status as a prof

As opposed to rely on the anecdotal say-so of IFIC?

The IFIC has $millions at its disposal. Strange that they've never managed to produce a peer-reviewed study to show what a wonderful deal Canadian mutual fund investors are getting. Could it be that they haven't done so because they can't?

[mikester]

I can't believe I'm going to defend the mutual fund industry and their excessive fees but why are the fees charged by mutual funds companies (and their salespeople aka FAs) any different than any other industry?

If you've gotten any renovation work done recently you might have noticed that it cost a lot more than just a few years ago - especially if you live in Alta. Why is that? And what about real estate fees? Thanks to real estate prices going up so much over the last 15 years, their fees have gone up way more than inflation. And what about the price of bread at my local corner store? It's at least 20% more than the grocery store which is a bit further (or closed).

If you want convenience you pay for it.

[AltaRed]

I can't believe I'm going to defend the mutual fund industry and their excessive fees but why are the fees charged by mutual funds companies (and their salespeople aka FAs) any different than any other industry?

The issue is why is Canada above the costs in other countries as noted upthread. It is not that people should not pay for convenience and professonal advice.

[mikester]

Good point, AltaRed but that begs the question, how do fees charged in industries other than the MF industry compare to other countries?

I remember reading articles about Europe before they started the whole economic union thing and how the prices in different countries were quite different for the same product. I'm thinking that might have been true for services as well.

[Bylo Selhi]

I can't believe I'm going to defend the mutual fund industry and their excessive fees but why are the fees charged by mutual funds companies (and their salespeople aka FAs) any different than any other industry?

Ellen Roseman has not one but five answers for you

Few object to fund fees, so firms are adding more

First, most people don't want to make the hard decisions about buying and selling securities...

Second, investors don't think a total expense ratio of 2.2 per cent – according to the latest version of the study – is unreasonable...

Third, investors don't understand low-cost index funds and exchange-traded funds. They hope to beat the market, not just keep pace with the market indexes...

Fourth, investors don't realize how fund sellers are paid. Many think they're getting the advice for free... Economies of scale? Forget it. The larger funds grow in Canada, the less likely they are to give investors a break on fees...

Finally, investors don't tend to leave their financial advisers – even when the service consists of an annual phone call to solicit the next RRSP contribution...

[DanH]

I guess I don't understand your motive in criticizing the study or its authors then, Norm. Are you interested only in statistical accuracy but not in any lesson that might be drawn from the statistics once they are accurate?

Let's look at what the authors are actually saying here. While I read the fully May 2006 paper I have yet to read the full 2007 draft. But what stood out in the latest version was the authors' warning not to spend too much time looking at raw fee differences. (See bottom of p.10 of the latest draft.)

They say this because they concede that they've not teased out all of the nuances in each country. I'm not saying it - the authors have admitted this. So, if the raw differences exclude some significant - or potentially significant - fees paid by investors, how much confidence can you have in their overall conclusion or the raw differences?

It seems to be far better to rely on one's status as a prof

As opposed to rely on the anecdotal say-so of IFIC?

The IFIC has $millions at its disposal. Strange that they've never managed to produce a peer-reviewed study to show what a wonderful deal Canadian mutual fund investors are getting. Could it be that they haven't done so because they can't?

Because nobody can, I suspect. And this is part of the problem. The authors use this term, TSC or Total Shareholder Costs, and what they've quantifying is really Total Direct Product Costs. They make no attempt to look at the extent to which people engage the services of an advisor.

That's fine but how misleading is a figure called TSC when, in fact, yoiu're not quantifying total investor costs? This is what IFIC is calling for because, I suspect, of the terminology they've chosen. Yet, the authors are not interested in this figure. They want to work with what's in their database, and move on to regressing the (potentially misleading) fee differences against things like income levels, investor protections, market structure, competition, etc.

In other words, IFIC wants something that the authors have no interest in providing. The other problem is that the media picks up on the very issue that these supposedly credible authors have told them not to. And when otherwise credible people so casually quoted the original 4.7% TSC figure that was so obviously ridiculous, it makes me wonder what their true motives are.

I think what Norm is saying is this: If a fund company made a similarly ridiculous claim, the media would have chewed it up and spit it out. And then, they wouldn't bother giving it any more exposure because they wouldn't trust anything else that came from that source, particularly when the research is not yet complete. That doesn't puzzle anybody else?

[Dennis]

Pogo: We have seen the enemy, and he is us...

[Norbert Schlenker]

But what stood out in the latest version was the authors' warning not to spend too much time looking at raw fee differences. (See bottom of p.10 of the latest draft.)

They say this because they concede that they've not teased out all of the nuances in each country. I'm not saying it - the authors have admitted this. So, if the raw differences exclude some significant - or potentially significant - fees paid by investors, how much confidence can you have in their overall conclusion or the raw differences?

Fair enough. Going back to Oz because it looks cheap in the paper, I googled this am for managed funds and the first thing that popped up was a family of them from Macquarrie Bank. Look at the prospectus and it looks like the all-in pack on a balanced fund is about 2.5%, which includes GST and a trailer to advisors. (It looks like Oz regs require bundling these things in with and disclosing them as part of overall fees, so it's not dissimilar to our regs.) So the fee levels are comparable.

The overall lower fees in Oz per the paper could be accounted for by presuming that advisory fees are billed separately. See http://www.financialwebring.org/forum/v ... 787#155787 for example.

I think what Norm is saying is this: If a fund company made a similarly ridiculous claim, the media would have chewed it up and spit it out. And then, they wouldn't bother giving it any more exposure because they wouldn't trust anything else that came from that source, particularly when the research is not yet complete. That doesn't puzzle anybody else?

You know as well as I do that there is no lack of big media distributing financial pornography that originates from IFIC and its members, nor has getting criticized for uncritical redistribution stopped them from going back to the same well for more "information" later. What would make you expect them to be more skeptical / critical of academics?

P.S. Tell Norm I still love him, would you.

P.P.S. Good of you both to be voices of reason.

[Bylo Selhi]

There's value out in fund land, if you're willing to hunt for it

PH&N will create a new "B series" version of its existing fund lineup that will take the firm's ultralow management expense ratios and add trailers at half the usual industry rate. The net result will be funds that offer compensation to advisers while making other funds look expensive. PH&N president John Montalbano said the new B funds are a way of reaching out to investors who want to work with an adviser while also maintaining its long-standing commitment to holding down fees. "We're not against advisers getting paid, we're just against high fees," he said.

It will be interesting to hear the arguments from the commissioned crowd about why a fund like PH&N Dividend is inferior to whatever higher-trailer "dividend" fund they're pushing in its stead

It will also be interesting to see if the discount brokers who now offer PH&N's A-class funds without added fees will now offer only the B-class variants and, if so, hear their arguments.

[Slippy]

There's value out in fund land, if you're willing to hunt for it

PH&N will create a new "B series" version of its existing fund lineup that will take the firm's ultralow management expense ratios and add trailers at half the usual industry rate. The net result will be funds that offer compensation to advisers while making other funds look expensive. PH&N president John Montalbano said the new B funds are a way of reaching out to investors who want to work with an adviser while also maintaining its long-standing commitment to holding down fees. "We're not against advisers getting paid, we're just against high fees," he said.

It will be interesting to hear the arguments from the commissioned crowd about why a fund like PH&N Dividend is inferior to whatever higher-trailer "dividend" fund they're pushing in its stead

It will also be interesting to see if the discount brokers who now offer PH&N's A-class funds without added fees will now offer only the B-class variants and, if so, hear their arguments.

Meh.

Just marketing smoke and mirrors.

IMO PH&N gets far too much credit for thier so-called "low MERs". They don't really charge any less to manage money than anyone else on the street. It just looks that way becasue they don't pay trailer fees and therefore don't have to include them in the MER calculation. Anyone using a full service advisor and PH&N will simply pay a seperate fee (say 1%) which effectively removes the savings/lowers the return to the client anyway.

Discount brokers will continue to offer Class A with an extra fee tacked on, or Class B with the built-in fee. You don't get something for nothing in this world.

[Shakespeare]

Discount brokers will continue to offer Class A with an extra fee tacked on

Scotia Discount offers Class A with no fee.

[AltaRed]

Discount brokers will continue to offer Class A with an extra fee tacked on

Scotia Discount offers Class A with no fee.

As does E*Trade, but Bylo has a good point. Will they continue to do so once B class comes available? I think the jury is out because they will (can) argue that this should be no different than the trailers they get now from other funds.

[DanH]

The overall lower fees in Oz per the paper could be accounted for by presuming that advisory fees are billed separately. See http://www.financialwebring.org/forum/v ... 787#155787 for example.

Could be but the paper doesn't get into those details and their end point is 2002 - which is well before the unbundling trend you linked to above so it's not clear if that even impacted this particular paper's study.

You know as well as I do that there is no lack of big media distributing financial pornography that originates from IFIC and its members, nor has getting criticized for uncritical redistribution stopped them from going back to the same well for more "information" later. What would make you expect them to be more skeptical / critical of academics?

I would say that the mainstream media (i.e. chevreau, carrick, roseman, daw, leatherdale, etc.) is anti-industry and pro-consumer - on balance. That's typical of media in different sectors. I think it's a healthy balance for the reason you cite - i.e. that industry comes out with research that supports its M.O. But when the industry comes out with silly claims, I'm equally vocal.

[NormR]

P.S. Tell Norm I still love him, would you.

I'm feeling the love

[Bylo Selhi]

[dinomorea]

Basically speaking I too dont see any such great idea behind this 2.5% issue but I guess there are no other best alternatives other than the mutual funds at present and that is one reason more and more people are coming luring towards it. However I would be glad to hear some expert opinions about this aspect here.

[Bylo Selhi]

Although the paper’s comparative fee data still have limitations, its figures for Canadian funds look accurate. But its estimated total shareholder cost of 2.4% annually for Canadian funds is meaningless, as it does not show the breadth of choice available for investors and advisors of all types (not to mention how that compares with other countries).

The vast majority of financial advisors are paid via product commissions. Accordingly, load mutual funds dominate the fund industry, both by number of funds and assets. Alternately, advisors who count themselves among the small, but growing, contingent of fee-only advisors have a large universe of F-series fund units (and other cheap products) that fit nicely with that model. And although most individual investors need and seek the counsel of advisors, there are many smart and savvy do-it-yourself investors who prefer low-cost products.

These investors, despite being in the minority, have a lot of choice courtesy of no-load companies and exchange-traded fund providers. For instance, a DIY investor can build a diversified portfolio (i.e. 60% stocks, 40% bonds) for less than 0.3% per year (if using index or passive funds). It is also easy to build portfolios of actively managed mutual funds for all-in costs of about 1% annually. Canadian investors can also access, from any Canadian brokerage account, cheaper ETFs and actively managed closed end funds on U.S. stock exchanges.

Hence, if an industry is supplying at least enough products to serve both DIY investors and advice seekers, then I would argue that there is little meaning in our average fees.

Although I believe there are far too many load mutual funds in Canada, the breadth of choice to suit different investor and advisor needs serves us well.

Let's refocus this on the commissioned financial advisers who are predominant in Canada. Let's also assume that they deserve to be paid 1% of assets for their services. Now we have a large body of academic studies that demonstrate that what these folks sell, actively-managed mutual funds, underperform their indexed counterparts.

You concede that the average fund in Canada charges 2.4%. (That's actually lower than the average actively-managed fund if index funds and ETFs are included in that average.) You concede that one can build an indexed portfolio for 30bp or less. Add to that 1% for the adviser and the cost to a client investor is 1.3%, i.e. over 1% lower than what they're now paying. Moreover, an indexed portfolio has a very high probability of outperforming a similar actively-managed one so there's a clear benefit to the investor regardless of MER.

You and others have pointed out that the true customers of the dominant fundcos are the advisers who sell their "products." Presumably these advisers' mandate is to create the best possible portfolios for their clients. (If that's not their mandate, then what is?) So why aren't advisers clamouring to their fundcos for low-cost index funds (with the usual 1% embedded commissions) instead of inferior actively-managed funds?

How can you claim that "the breadth of choice to suit different investor and advisor needs serves us well" when so few advisers use superior, lower-cost passive alternatives that would serve Canadian investors not only well, but better than the stuff that's driving the average MERs so high?

[DanH]

I don't have time for a debate today. In fact, I'm writing another article for my website that will more directly get at some of the things you've said. For now...a very quick response...

First, you left out my favourite part of the article:

Although the paper’s early drafts date back to 2005, a final version was completed in 2007 and is slated to be published later this year. As I was perhaps the harshest and most vocal critic of this paper, I take a certain amount of pride in pointing out that its final estimate of Canadian funds’ total shareholder costs (i.e. management expense ratio, plus annualized loads) is 2.4%, about half of the earlier 4.7% per year estimate.

Now, you said...

Now we have a large body of academic studies that demonstrate that what these folks sell, actively-managed mutual funds, underperform their indexed counterparts.

I've read many of those studies. Not one that I've seen has deducted 1.5% to 1.9% from index returns (see below for relevance of these figures).

You concede that the average fund in Canada charges 2.4%.

I didn't say that. The paper's authors did. But that's not MER, that's MER + annualized loads, which are a bit overestimated because of the formula used. And that's not the average fund, that's supposed to be a weighted average figure, as of 5+ years ago.

(That's actually lower than the average actively-managed fund if index funds and ETFs are included in that average.)

The authors don't specify, or maybe I missed it, but this is a mutual fund database so I believe ETFs are excluded - as are seg funds.

You concede that one can build an indexed portfolio for 30bp or less. Add to that 1% for the adviser and the cost to a client investor is 1.3%, i.e. over 1% lower than what they're now paying.

30 bps was the lowest estimate. The average iShares ETF MER is 0.43%. And most advisor fee schedules I've seen start at 1% to 1.4% per year. They scale down from there, in varying degrees. But that puts the all-in cost (with GST) at 1.5% to 1.9% per year. I believe the latter figure would also qualify as "most expensive in the developed world" to quote a rather popular phrase these days.

Moreover, an indexed portfolio has a very high probability of outperforming a similar actively-managed one so there's a clear benefit to the investor regardless of MER.

Regardless of MER? Really? I'll give you a chance to edit that before I respond. Before you do that, I'll advise you to first find a study that has deducted 1.5% - 1.9% from index returns.

So why aren't advisers clamouring to their fundcos for low-cost index funds (with the usual 1% embedded commissions) instead of inferior actively-managed funds?

There are many reasons. Not everyone believes this is best. Advisors invest their own money they way they invest for their clients, by and large. So, they're not being deceitful - at least not the ones I'm familiar with.

How can you claim that "the breadth of choice to suit different investor and advisor needs serves us well" when so few advisers use superior, lower-cost passive alternatives that would serve Canadian investors not only well, but better than the stuff that's driving the average MERs so high?

So are you saying that the ETF industry is better today with 1,100 ETFs globally instead of just sticking to the basics, to the fundamentals supported by the academic theory?

Choice is good. Too much choice is bad for investors. The fund industry is proof of that. ETFs are now following suit because some academics are grouping into proverbial industry bathrooms, unzipping, and sizing up their...indexes.

[mikester]

Not one that I've seen has deducted 1.5% to 1.9% from index returns (see below for relevance of these figures).

I agree that comparing mutual funds directly to the index returns is inaccurate, but subtracting 1.5% to 1.9% is the extreme situation where someone is paying 1%+ to an advisor.

Most investors are probably better off with an advisor since they are too lazy to learn anything about investing on their own. One of the big benefits of low cost index funds and ETFs is for the diy investor because it allows them to participate in equity markets in a diversified fashion. Until fairly recently (F series), a diy investor was very limited in terms of buying normal retail mutual funds so etfs were the obvious way to go.

I agree about the proliferation of ETFs - just more marketing.

Mike

[DanH]

Not one that I've seen has deducted 1.5% to 1.9% from index returns (see below for relevance of these figures).

I agree that comparing mutual funds directly to the index returns is inaccurate, but subtracting 1.5% to 1.9% is the extreme situation where someone is paying 1%+ to an advisor.

That's not extreme. That's the reality for clients going to advisors for ETFs.

Until fairly recently (F series), a diy investor was very limited in terms of buying normal retail mutual funds so etfs were the obvious way to go.

There has long been lots of choice for low fee active funds...PH&N, Beutel Goodman, Mawer, Leith Wheeler, Saxon, Chou, McLean Budden, Legg Mason Canada (until a couple of years ago), Steadyhand (as of a year ago). Maybe others I can't recall off hand.

[mikester]

There has long been lots of choice for low fee active funds...PH&N, Beutel Goodman, Mawer, Leith Wheeler, Saxon, Chou, McLean Budden, Legg Mason Canada (until a couple of years ago), Steadyhand (as of a year ago). Maybe others I can't recall off hand.

True but most of those have substantial minimums so not available for everyone.

mikester wrote:
Quote:
Not one that I've seen has deducted 1.5% to 1.9% from index returns (see below for relevance of these figures).


I agree that comparing mutual funds directly to the index returns is inaccurate, but subtracting 1.5% to 1.9% is the extreme situation where someone is paying 1%+ to an advisor.


That's not extreme. That's the reality for clients going to advisors for ETFs.

Hmmm...I don't really disagree with you but I think that assuming the amount of fees a "typical" investor would pay is kind of like trying to account for taxes - we never do it because everyone's situation is different.

[Bylo Selhi]

First, you left out my favourite part of the article:

I figured you'd prefer to toot your own horn

I've read many of those studies. Not one that I've seen has deducted 1.5% to 1.9% from index returns...

I don't claim that my annual Performance of Indexed vs Actively-Managed Portfolios for the 15 years ending is academically rigorous, however, even after it subtracts 50bp for index fund MERs the margin of outperformance still exceeds 1%, i.e. enough to pay the adviser. Moreover, there's no need for the adviser select which actively-managed funds to use nor for their clients to assume the risk that their choices actually will outperform.

The average iShares ETF MER is 0.43%. And most advisor fee schedules I've seen start at 1% to 1.4% per year.

If an adviser can make a living from 1% (either all trailer or 50/50 DSC/trailer) then why can't they do likewise from 1% with index funds? Again they should be able to charge slightly less since there's less effort to select index funds than actively-managed ones.

Regardless of MER? Really?

:oops: Badly worded on my part. Let's strike that sentence altogether.

There are many reasons. Not everyone believes this is best. Advisors invest their own money the way they invest for their clients, by and large. So, they're not being deceitful - at least not the ones I'm familiar with.

If not deceitful then apparently lazy and/or close-minded. (Or have advisers as a whole managed to somehow debunk 50 years of advances in finance? And if they have, then why haven't they shared their wisdom with those they claim to have debunked?)

Choice is good. Too much choice is bad for investors.

No doubt that too much choice is bad, especially when the differences are often superficial. Why is it that the fundcos, who manage the vast majority of investor's money through commissioned advisers, offer a plethora of actively-managed funds, many of which target the same asset classes with only minor differences, yet they offer no index funds to the same audience? Do they believe that none of the advisers who offer their funds would find indexing beneficial to their clients?