Mutual Fund Fee Debate: The Industry Response

September 7th, 2006 · 12 Comments

Jonathan Chevreau dissects the industry response to a firestorm of criticism over the high fees charged by Canadian mutual funds in today’s edition of The Financial Post ($). The rebuttal by Dan Hallett that Mr. Chevreau refers to is available here.

The original study points out that the average MER charged by a Canadian fund is 1.97%, the total expense ratio (TER) is 2.68% and the “total shareholder charges” (taking into account front-end or back-end loads) is 4.66%. Canadian mutual fund fees are the highest in the developed world in all those data points. Mr. Hallett’s rebuttal mostly concerns with how sales charges were calculated in the study. Even if we ignore the sales charges completely, the average TER of a Canadian fund is 2.68% (still the world champion) compared to 1.42% for the average American fund. Over a period of 25 years, if Canadian and American fund returns were the same before fees (let’s assume it is 10%), an initial investment of $1,000 would grow to $7,800 in an American fund and only $5,800 in the Canadian fund.

Of course, the old argument of the fund industry is that their active management is superior to traditional indices. Mr. Hallett writes:

Moreover, the authors of the draft paper admittedly do not address if Canadian investors get good value for the higher fees they pay. While Canadian MERs are undoubtedly high, a measure of benefits received vs. costs incurred is key to determining whether Canadians are indeed being duped, as has been suggested by some journalists. Yes, we pay more than many other countries, but this draft paper is far from conclusive due to its preliminary nature and the weaknesses identified.

Unfortunately for the industry, Standard & Poors does keep a scorecard of indices versus actively managed funds (the latest is available here). According to this latest report, a mere 14% of Canadian equity funds outperformed the S&P/TSX index and 25% of US equity funds outperformed the S&P 500 index over a five- year period. Seems to me that we are a nation of mutual fund “suckers” paying more and getting less in return.

12 responses so far ↓

1 James // Sep 8, 2006 at 1:02 am

The mutual fund industry does not have a reasonable comeback in this case.

Unfortunately, it doesn’t really matter. In the end, it comes down to investor education. Most ‘investors’ are really just looking for an ‘expert’ to make sure they are ‘doing the right things’.

Speaking as someone who just got out of Investors Group into a self-directed RSP, I had to make a conscious decision to actually learn about what I was investing in. Most people are not willing or just can’t put in the time to do this.

It is those people who are paying the high fees, and the mutual fund industry actively courts them.
2 Mike // Sep 8, 2006 at 8:40 am

Are there any positive correlations between higher MERs and a fund’s performance? That might help justify the higher expenses….(but I have yet to see such information)
3 MikeB // Sep 8, 2006 at 2:29 pm

Mike, I asked that exact question to Gordon Pape directly and he flat out said no. He is a well known financial planner in Canada.

I recently left RBC Dominion Securites to take my RRSP self directed. I’m no longer interested in mutual funds but Canadian markets are undiversified and seem to be on the high side of valuation, and it looks like we’re facing the likelyhood of a commodities pull-back. I’m starting to look at ETF’s that will get me exposure to international (read european and asia pacific) markets.

This is great blog, keep up the good work!
4 Buy_High_Sell_Low // Sep 8, 2006 at 3:39 pm

A few years ago, my wife opened some RESPs at CIBC for the kids. They recommended funds which hold a balance of number of other CIBC funds.

When I looked at this this year, the MER seemed a bit high for this type of fund… Ouch.

Then it occurred to me that we were paying this in ADDITION to the MER of the ‘inner’ funds. OUCH!

The kids are in a low-MER dividend fund now.
5 Canadian Capitalist // Sep 9, 2006 at 10:59 am

Buy_High: You may want to consider TD eFunds. Very easy to construct a fairly diversified portfolio which I have done for my boys’ RESPs.

Mike: Several studies have shown a negative correlation between high MER and fund performance. The logic is simple: mutual funds as a whole make up the market and as a whole they will provide returns equal to the market less the fees and expenses charged by them. Ergo, the higher the fees, the lower the returns for investors.

MikeB: I agree with you that the Canadian market is very undiversified if you strip out financials and resources. For ETFs, you might want to consider VTI (broad market US), IVV (S&P 500), IJR (US small-cap), EFA (developed international) and EEM (emerging markets). Or try etfconnect.com for more research. Good luck!
6 Phil S // Sep 9, 2006 at 8:23 pm

Hey everybody! I just wanted to let you all know that I switched out of a Scotia McLeod Group RSP plan in favour of a self-directed BMO Investorline account many moons ago. However, it was recently brought to my attention by a co-worker that Interactive Brokers has the lowest commissions in Canada, only $0.01 per share at any price, and a minimum of a measly $2! I don’t know about the rest of you but BMO is about $29 per transaction!

I haven’t figured out how best to switch to Interactive yet… I think it may leave everything “as is” and open a non-RSP account to do all of my trading in the future on Interactive. Mainly because I invest in a lot of small, micro and venture cap companies where $29 can make a huge difference between a profit and loss.

Also, I thought that I would mention a class of investments that I just recently started to get into… Private Equity. Unfortunately in Canada, you really only have one choice, Gerry Schwarz’s Onex Corporation and it doesn’t have very good metrics. But down in the USA, Private Equity firms are abundant! From the highly visible KKR to the small fry, like Apollo Investment (AINV on Nasdaq) and Ares Capital (ARCC on Nasdaq), etc. The reason why I mention these firms is because they each hold a huge portfolio of businesses so in essence they are each quite diversified… So for all intents and purposes, they are mutual funds! And they yield about 9% dividend per annum! It’s an alternative for you all to consider rather than ETFs and mutual funds.

These Private Equity firms usually buy into failing businesses and turn them around, or they buy companies which have some kind of leadership succession problem, or they simply buy private debt instruments! In any case, these guys are extremely shrewd, they only buy businesses at deep discounts, and make huge profits when they exit their positions. So, my philosophy is why buy the companies that they spin off? Just buy shares of the listing company!!! =0)
7 Neil Jensen // Sep 10, 2006 at 12:18 pm

Tom Bradley also has some good commentary on this issue at http://blog.steadyhand.com/tombradley/2006/08/youre_paying_to.html

(Disclaimer: I work with Tom and am obviously biased on this issue)
8 Canadian Capitalist // Sep 11, 2006 at 7:21 pm

Neil: Thanks for pointing me to the SteadyHand blog.
9 Sharon A // Nov 27, 2006 at 5:01 pm

Are TD’s e funds still around? If not, what happened to them…
10 Bryce // Nov 27, 2006 at 6:15 pm

efunds are still around

http://www.tdefunds.com/
11 Canadian Capitalist // Nov 27, 2006 at 6:17 pm

Thanks Bryce. Sharon, eFunds are definitely still around and I am invested in them.
12 Insurance // Jun 23, 2007 at 3:46 am

eFunds are very much still around. Yah.

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