Canadian mutual fund fees are not higher than those found in other countries. Sometimes they are even lower. The Investment Fund Institute of Canada (IFIC) announced this conclusion in a study that contradicts earlier findings.
In its study called Understanding Management Expense Ratios, IFIC takes umbrage at the views conveyed by studies published in recent years. It hurls particular vitriol at Morningstar, whose report released last March gave Canadian mutual funds a grade of F (worst rating) for MERs. In several fund categories, fees for Canadian funds rank highest in a sample of 22 countries.
The Morningstar study found a clear advantage of American funds over Canadian funds, based on the median fees observed (the median is a number situated midway between the highest and the lowest numbers in the sample). The study found that the median MER of fixed income funds is 1.31% in Canada and 0.75% in the United States. For equity funds, the Canadian median is 2.31%, versus 0.94% in the United States. For money market funds, the Canadian and American medians are 0.80% and 0.47% respectively
Another study, Mutual Fund Fees Around the World released as a draft in 2006 depicted Canada as a place where investors paid the highest MERs in the world. Based on work done in 2002, three researchers from Harvard Business School, London Business School and the Georgia Institute of Technology concluded that Canadian investors paid average management fees of 2.68% per year, whereas American investors paid an average of 1.42% for their mutual funds.
IFIC accuses these earlier research studies of ignoring the distinctions between the Canadian fund market and other markets such as the United States. Follow-up commissions or service fees are a compelling example. IFIC points out that the MER ratio of Canadian funds includes advisor compensation. In the United States, these fees are charged separately.
IFIC’s figures are comparable with those cited by other studies, although they revise American and international fees upward. IFIC reports a median ratio of Canadian equity fund MERs of 2.23%, versus 2.45% for an international equity fund.
“When proper cost comparisons are made (i.e. when the comparison is made for similar bundles of services), it has been shown that mutual funds, and the individual advice that comes with them, provide good value for Canadians relative to alternative savings vehicles, and relative to funds sold in other countries,” the IFIC study states.
Other factors distort the picture because current comparisons do not take them into account, IFIC adds. For instance, front-end fees are negotiable in Canada but not in the United States.
“The U.S. fund investor purchasing less than $100,000 worth of funds will actually pay between a 4% and 6% front end commission. In Canada, between 90% and 95% (depending on the fund company surveyed) of new front-end fund purchases have commissions negotiated at 0% and for those investors that do pay a commission, the amount is typically 2% or less,” the study reports.
Taxes also skew the comparison, IFIC continues.” Canada is one of the only countries that fully taxes the services provided to mutual funds – the management and administration fees – through its application of the GST or HST (depending on the investor’s province of residency).”
IFIC describes this additional cost in detail: “On a fund with a 2% management fee and 0.20% operational costs, this adds another 11 bps (5%) to 29 bps (13%) to the total MER depending on the province considered.”
IFIC’s final argument: fund size (see Canadian funds one quarter the size of US funds). The Institute contends that size is a factor that affects both individual funds and the global mutual fund market: ”Economies of scale should tend to lead to lower MERs in countries with relatively larger funds.”
Transparency, a stumbling block in Canada
Jon Cockerline, director of policy and research at the IFIC, calls the conclusions of the other studies mentioned above superficial. “(The Canadian mutual fund industry is) being penalized for being very transparent in our pricing,” he told The Insurance and Investments Journal in an interview.
He argues that the Mutual Fund Fees Around the World study neglected to highlight the four differentiating factors that IFIC describes in its study. As a result, funds are not compared on the same footing, he says.
Transparency implies that the amount paid for advisor services is visible in the management expense ratio. “Mutual funds give you access to advice that you’d have to pay for otherwise,” Mr. Cockerline says. He explains that the majority of mutual funds currently managed in Canada are used for RRSPs or registered retirement income funds (RRIFs). This clientele needs advice, he adds.
If some plans offer lower fees, they also offer fewer services, he continues. Defined contribution group pension plans, which contain mutual funds with reduced fees, are one example. Another example, exchange traded funds have very low fees, but do not include any advice.
However, there are certain things one should know about ETFs. For one, 80% of these funds underperform benchmark, Mr. Cockerline says, citing another IFIC study published in July that compares the performance of active and passive investments.
Details are overlooked too often, Mr. Cockerline says. American mutual funds charge a non-negotiable acquisition fee of 5% on average. For Canadian funds, these fees are reduced or even eliminated in over 90% of cases, following an agreement between the advisor and the client.
Morningstar fires back
Nothing but a smokescreen, detractors of high fees call the “skewing” factors mentioned by the IFIC. David O’Leary, director of fund analysis at Morningstar, has heard these arguments before. He concedes that the inclusion of service fees in the Canadian ratio is an essential difference. “Even so, there’s still a price gap that exists (between Canadian and U.S. funds),” he says.
Mr. O’Leary disagrees with the IFIC over the other factors. While saying that the fund industry can’t be blamed for the HST, he believes that it does increase investor’s costs and should be included in fee comparisons.
Yet he notes a positive shift in the industry, which he attributes to pressure arising from the success of ETFs and public opinion. “We are seeing more and more versions on the market of traditional funds at reduced fees, but low fee version funds are still a low proportion of the Canadian market,” Mr. O’Leary says.
He is not convinced by IFIC’s argument about advice. He counters that many investors are paying needlessly for this service.
“There are funds, e.g. TD Waterhouse, that keep the trailer of 0.5% to 1.0 % even if investors didn’t receive any advice,” he says. This situation is not seen in the United States.
If investors were willing to pay advisory service fees blindly, there would be no problem, Mr. O’Leary explains. In fact, he has heard the contrary in the media for years: investors are fed up with the high cost of investment funds. This is why exchange traded funds have been so successful, he says.