While there is no doubt that fund-of-funds products are a popular choice, David O’Leary, manager of fund analysis at Morningstar Canada, says many of these products have excessive fees for what is being provided.
In analyzing these funds, Morningstar takes into account the weighted average of the funds in the program. As a simple illustration, if there were only two funds in a portfolio, one with a managing expense ratio (MER) of 2.0 and the other of 3.0, then the weighted average is 2.5. Mr. O’Leary says that the portfolio fee shouldn’t be higher than the weighted average.
But, he says that fund companies will tell you that charging an extra premium on these fees is justified by the service provided, such as rebalancing the portfolio. However, since they are meant to be the investor’s core portfolio, investors will put more money into them and keep it there. Therefore, this is a good deal for the fund company, he says. "The fund companies are getting stickier assets, so we don’t see why they should charge more"
How many companies are charging above the weighted average? "More funds than not," he says. Some are a little over and "some are egregiously overpriced."
Interestingly, while the MER on conservative portfolios with less risky fixed income assets might have lower MERs, Morningstar has found that the premiums on these investments are often higher than aggressive growth or balanced portfolios. As a simple example, if the weighted average of a conservative portfolio was 1%, but the company was charging 1.5%, then the premium would be 50%. Alternatively, the weighted average of an aggressive portfolio might be 2.5, but the company might charge 3.0%. While the MER is higher for the aggressive growth portfolio fund, the fee premium is far lower at 20%.
Will increasing competition in this category bring down fees? "You’d like to believe that, but the problem is that a lot of companies…price to their peers," he says. If investors aren’t complaining then it is unlikely that the companies will bring the fees down, he adds. "Fund companies tend not to wage war on fees." Instead, they compete on other aspects such as the services they offer, selling their expertise and branding. "I’ve never seen an aggressive price war in the mutual fund industry."
Dennis Yanchus, statistics analyst with The Investment Funds Institute of Canada (IFIC) says that while IFIC hasn’t done a study on fund-of-funds fees, anecdotally he believes that they have been coming down in the last two years. He compares fund-of-unds fees to what you might see on a Global Equity fund.
Meanwhile, John Rees, director, investment sales at Equitable Life, says that while the fees are a little higher, they are justified by the performance and management. "We think there is tremendous value," he says adding, "Advisors are voting with their sales."