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Mutual Fund News

In tough times, fees matter more

When funds lose money, investors suddenly wake up to how much MERs dent returns. Yet few are showing concern, pros say

INVESTMENT REPORTER

When investors look at the eye-popping returns posted by some mutual funds in the heady days of a bull market, they may not even notice the fee included to pay for that performance.

But then along comes a year like last year, when a fund loses 20 or 30 per cent -- as some did in 2001 -- and suddenly, some may more closely question the 2 or 3 per cent they are paying a professional to manage their money for them.

Canadians generally pay higher fees than their U.S. counterparts, says Dan Richards, president of Strategic Imperatives, a Toronto-based financial-services consulting firm -- but funnily enough, they don't seem to care.

"The fact is that, historically, Canadian investors can only focus on one number at a time -- and that number is the return," he says.

Analyst James Gauthier of Fundmonitor.com says the financial advisers he talks to say their clients show very little concern about fees.

Mr. Gauthier does not see fees falling in this country until U.S. mutual-fund companies move in and offer competition -- and he does not expect that will happen any time soon.

"There are just too many regulatory roadblocks," he says.

In Canada, investors can buy no-load funds, which do not have a commission attached for buying or selling. But choice is limited.

Funds with front-end loads have a commission at the time of purchase, while back-end load funds have a commission if the investor sells within a certain time.

Funds also have a management expense ratio (MER), which is the total of the annual management and operating expenses expressed as a percentage of assets.

A fund's fees pay for things like the manager's salary, unitholder accounting, trailers or commissions, glossy advertisements in financial magazines and the cost of mailing out prospectuses.

The net return on a fund is calculated after deducting the MER from the gross return. If your fund posted a gross return of 12 per cent and had an MER of 3 per cent, you would reap a 9-per-cent return.

MERs can vary widely among funds of the same class. MERs on Canadian equity funds range from 0.2 per cent for the SEI Canadian Equity Fund to 5.28 per cent for the CEO Hirsch Canadian Fund.

SEI Canadian Equity is managed by a team at Seamark Asset Management Ltd. CEO Hirsch Canadian is managed by Hirsch Asset Management Corp., which is headed by Bay Street veteran Veronika Hirsch.

Malcolm Hamilton, a principal with William M. Mercer Ltd. in Toronto, says investors should realize that fees can have a considerable impact in the long run.

Say, for example, you invest $1,000 in a fund with an MER of 2.5 per cent. After 15 years, you would lose 32 per cent of your contribution to fees and, after 25 years, you would lose 47 per cent.

But compare that with a low MER of 0.5 per cent. After 15 years, that fee costs you only 7 per cent of your contribution. After 25 years, the amount is 12 per cent.

As Mr. Hamilton points out, if a manager can beat an index by 2.5 percentage points, you haven't lost.

"But the average investor ends up with the average manager and the average manager is not going to add 2.5 per cent per annum -- the average manager is going to struggle to add 1 per cent."

The numbers do show how MERs eat into returns in the long run.

For the 15 years ended Dec. 31, 2001, for instance, the top 15 Canadian equity funds averaged management expense ratios of 1.53 per cent and produced an average compound annual return of 11.2 per cent, according to Globe HySales.

Meanwhile, the bottom 15 funds charged an average MER of 2.6 per cent and returned an average 6.1 per cent.

But these long-term figures are only a rough guide of an MER's impact on performance. Analysts caution that these numbers do not reflect changes in MERs over the years.

Still, even if Canadians do rail against higher fees on this side of the border, analysts don't see fund companies responding.

Peter Loach, a fund analyst with BMO Nesbitt Burns Inc., says investors who don't like paying fees in bad times need to remember that the companies don't hike their fees in good times.

"If growth recovers and growth funds rise 50 per cent, are they going to raise fees by 50 per cent?" the analyst asks.

MERs are typically higher in Canada than they are in the United States, but Mr. Loach says U.S. fund companies can achieve many more economies of scale.

The U.S. also has low-fee companies such as Vanguard Group, which save on commissions by bypassing the financial adviser and selling index funds directly to the consumer.

Steve Kangas, an analyst at Fundlibrary.com, says that cutting fees is a no-win scenario for fund companies. For one thing, financial advisers earn a portion of the MER.

"Which fund company is going to cut off their nose by telling a financial adviser he has to take less?"

In other words, a financial adviser who receives a smaller fee from one company suddenly has a big incentive to recommend the funds of a competitor.

As an alternative, the fund company could maintain the financial adviser's cut and keep less for itself. But if it's a publicly traded company, as many are, management then has the job of explaining to shareholders why the company is earning less money.

The fund company may win some new investors as a result of the lower MER, but if that happens, the other fund companies will quickly follow suit.

Mr. Kangas likens the tactic to the price wars that gas stations sometimes engage in. The rivals keep cutting prices until they both lose money.

Mr. Richards believes Canadians who are becoming more savvy about fees are looking for alternatives to mutual funds entirely.

He says well-to-do investors, with $1-million or more to invest, can pay a slim 1-per-cent fee to an investment counsellor who will set up and manage a portfolio.

Mr. Richards says such services were generally available only to the very wealthy in the past.

"The investment counsellors have dropped their minimums. They've become much more aggressive in marketing," he says.

Dan Hallett, an analyst with Sterling Mutuals Inc., says some investors are turning to exchange-traded funds.

ETFs are similar to mutual funds, but they trade on stock exchanges. ETFs track specific indexes and have low management expenses.

"They're a good vehicle and they definitely could have a place in a portfolio," he says.

The most popular ETF in Canada, the iUnits S&P/TSE 60 Index Participation Fund, for example, has a management expense ratio of just 0.17 per cent.

Investors who do want to stick with mutual funds can ferret out some highly recommended funds that also boast low MERs.

Mr. Hallett points to the Trimark Canadian SC Fund, which has a stellar track record and a skinny 1.6-per-cent MER.

The analyst calls the fund a nice blend of value and growth.

Another fund on Mr. Hallett's list is the Mawer Canadian Equity Fund, which also blends value and growth and offers an MER of 1.55 per cent.

Investors looking for international exposure might try the Saxon World Growth Fund. Managed by Robert Tattersall, the fund posted a return of 12.97 per cent in 2001 and has an MER of 1.75 per cent.

Fees become particularly important when choosing bond funds, Mr. Hallett warns, because over time, managers have less opportunity to add value. "You don't have the same potential to add upside you do in a stock fund."

The analyst says the Phillips Hager & North Bond Fund has an MER of 0.57 per cent, while the Pergiee Index Plus Bond Fund has a 0.75-per-cent fee.

"The more conservative the fund, the more important fees become in the selection process," Mr. Hallett says.

© 2007 The Globe and Mail. All rights reserved.

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