Fidelity Investments is sparring with Canadian mutual fund manufacturers by offering the lowest management expense ratios. The opening salvos will cost the firm $25 million in 2005.

With new sales stagnating and a plethora of players crowding the market, the mutual fund industry has reached a crossroads. Pessimists fear that Fidelity’s recent reduction of its management expense ratios (MERs) is a desperate attempt to stop the painful flight by investors.

These fee reductions are intended to solve the asset retention problem. “First of all, this is a long term commitment. It’s a fundamental decision,” says Kimberly Flood, vice-president, external relations at Fidelity. “We will not be revisiting it. We’ve been thinking about it for some time now, so it’s not based on a short term trend.”

So, did the company reduce fees in order to retain assets? “Yes,” responds Ms. Flood. “We did it to retain assets and gather more. But it’s not an instant fix, and we did not intend it to be. It’s a long term commitment to offer more value to our clients. If it’s good for them, it’s good for our business.”

These fee reductions are going to cost Fidelity $25 million in 2005 alone, says Ms. Flood. They will also generate more costs in the years to come, depending on the assets, she adds. “But we’re willing to make that investment because our investors are going to save $12 million in the first year.” As to whether Fidelity is planning to make any further reductions in the near future, Ms. Flood simply replies, “we will keep an eye on the market.”

This initiative signals a fundamental change in the way Fidelity is taking on the Canadian market. A portion of the $25 million will be earmarked for the costs of transferring clients’ investments with deferred sales charges (fees decline over time to reach zero after six or seven years) to no-load funds at maturity. Advisors’ follow-up commission will then rise from 0.50% to 1% of assets.

On November 25, Fidelity announced a 20-basis point, or 0.20%, reduction of its MERs on its asset allocation funds, balanced funds and equity funds. MERs for fixed income and bond funds were reduced by 30 basis points, or 0.30%.

Data from the Investment Funds Institute of Canada (IFIC) revealed that many industry players are currently floundering. In November, net fund redemptions reached $280 million at AIC, $232 million at Fidelity and $188 million at CIBC. In all three cases, outflows had accelerated since October.

“It’s true that we would have preferred to report positive net sales in recent years,” says Charles Danis, vice-president, regional sales Quebec/Atlantic at Fidelity. “But in a way we were the victims of our own success. Between 1995 and 2000, Fidelity was the only company that sold $20 billion in new business. We took a very large share of the market very quickly. At some point, a correction is to be expected.”

Michel Fragasso, chairman of the board of the IFIC, welcomes the reductions announced in this sector. “Regulators wanted to do it, the media was complaining about overly high MERs. In the end, it’s the market itself that initiated the cuts.”

He denies that these decreases result from pressures by New York Attorney General, Eliot Spitzer, who slammed business practices in the industry last year. “This story involved mutual fund companies in the United States. It’s in the past. The fines were paid. Spitzer went on to something else, the insurance sector,” Mr. Fragasso explains.

For now, the IFIC chairman does not foresee similar decreases in segregated funds, products insurers offer. The life insurance component of these funds makes it harder to decrease MERs, he noted.

“Fidelity is a heavyweight,” Mr. Fragasso adds. “If it cuts its fees, others will follow. It’s good news for consumers who will get more for their buck. It’s also good news for the industry that had been harshly criticized in recent years.”

Nothing could be farther from the truth, insisted Jean Morissette, businessman and former executive-vice president and director at Dundee Wealth Management. “It is not positive for consumers at all. If the titans in the sector leap into a price war, one consequence will be the disappearance of the smallest players, who liven up the market. In the end, you can expect to see clients’ supply shrink.”

He commented that mutual funds have become a commodity, a mass product with no distinctive features, other than price, as far as consumers are concerned.

“Because of its size, Fidelity can afford to use this type of strategy, but it will hurt all the same,” Mr. Morissette warned.

Sustained decreases

Several factors foretell that decreases will continue. The bearish market returns are upping the odds, several stakeholders confirm. Steadily mounting competition by the banks, which offer mutual funds with competitive MERs, will propel other players to follow in Fidelity’s footsteps.

“This drop was inevitable,” stated Roger Beauchemin, senior vice-president at McLean Budden. His investment company manages $30 billion in assets for institutional investors, affluent investors and foundations. It is also a small direct distributor of mutual funds, requiring initial outlays of at least $10,000.

“The market will inevitably exert downward pressure on advisors’ fees. When you have returns of 7% and the fees are 2.5% or 3%, as is currently the case, consumers start to look elsewhere,” he explained.

In April, McLean Budden pared the MERs on its line of ten mutual funds, to the tune of five basis points. The MER of its equity funds was lowered to 1.25%, a rate below the Canadian average of 2.33%, the company maintains. Today, fees on balanced funds stand at 0.95%, versus 0.55% for money market funds.

This was the company’s third markdown in three years. “You have to keep fees as low as possible. Especially in a context of lacklustre markets, we had to make sure that the fees would not erode investors’ returns,” said Mr. Beauchemin. No further decreases are anticipated, he added.