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Mutual Fund News

A look inside fund returns

Expenses take a big bite out of the gains of many mutual funds, writes ROB CARRICK


Your mutual fund company is making good money off you in this bear market.

In fact, your fund company could very well be making more money off you than you are from the funds you own.

You see, mutual funds are one of those products where the cost to customers has no connection to performance.

Whether the stock markets are up or down, management expenses are invisibly deducted from your fund's returns. Whether you make or lose money on your fund, you pay.

In the grand scheme of things, this is an equitable arrangement reflecting the fact that buying a mutual fund means you are hiring an expert to run your money. For the relationship to work, both you and your fund company need to be rewarded.

Problem is, many funds are rewarding only their fund company masters these days.

Here's a quick illustration using an arcane but revealing measurement to see how well a fund earns its fees.

The average Canadian equity fund produced a compound average annual loss of 0.5 per cent for the five years to Sept. 30 while charging a management expense ratio over that period of an estimated 2.5 per cent. MERs are simply a fund's management fees expressed as a percentage of its assets.

If you add a fund's reported return to its MER, you get the gross return. With Canadian equity funds, the average gross return over the past five years was 2 per cent.

To recap here, the average Canadian equity fund's MER over the past five years ate up more than 100 per cent of its returns and left investors with a loss of 0.5 per cent a year.

In a perfect world, fund companies would use a system where their MERs rise in good years, say when returns reach double figures, and contract in bad years like the one we're having now.

In the real world, you need a practical way to assess whether your funds are earning their keep.

This is where the comparison of a fund's gross returns against its management fees comes in. This calculation was recently applied to U.S. funds by the Boston-based investment consulting firm Kanon Bloch Carré, but it hasn't been widely used in Canada.

We'll call this calculation the MER value indicator. The point of using it is to differentiate between funds that earn their MERs and funds that don't. The specific amount of a fund's MER is immaterial in this exercise; what matters is how that MER looks in relation to the fund's returns.

You can apply the MER value indicator to any fund, but for the sake of simplicity we'll look here at the Top 10 funds by assets in the Canadian, U.S. equity and global equity fund categories. We'll use a five-year time horizon here, which means the average MER and the compound average annual return for that period.

Among the Top 10 Canadian equity funds by assets there are funds that have definitely earned their MERs and some that have fattened themselves while unitholders went hungry.

The largest Canadian equity fund is Ivy Canadian, with $5.1-billion in assets. This fund's MER averaged 2.48 per cent over the past five years, while the compound average annual return for the five years to Sept. 30 was 5.4 per cent. Add these numbers together and you get a gross return of 7.9 per cent.

Now, how does the MER look in relation to this size of return? To find out, just divide the gross return number into the MER and multiply by 100. In this case, Ivy Canadian's MER has eaten up 31.4 per cent of its returns over the past five years.

That sounds hefty, but it's actually more than reasonable when you consider that the average Canadian equity fund charged more than it made.

An even better result was turned in by the $1.7-billion CI Harbour Fund, the tenth-largest Canadian equity fund by assets. Its five-year MER of 2.48 per cent ate up just 27.8 per cent of its five-year gross return.

Another good MER value was Fidelity True North, which had an MER that that accounted for 37.7 per cent of gross returns over the past five years.

AIC Diversified Canada and Royal Canadian Equity all took in slightly more in fees than they made in gross returns, while Trimark Select Canadian Growth made a little more than it took in. Compared with the rest of the Top 10 Canadian equity funds, that's not too bad.

Investors Summa's MER soaked up 98 per cent of its gross returns over the past five years, while Investors Canadian Equity, AIC Advantage and AIC Advantage II all lost money even before the MER was applied.

It's worth noting here that all but three of the Top 10 Canadian equity funds have a current MER below the category average of 2.63 per cent.

The MER bargain of the group is Royal Canadian Equity at 2.09 per cent, while the costliest MERs belonged to Investors Summa and Investors Canadian Equity at 2.97 per cent and 2.96 per cent, respectively.

The U.S. stock market has been a wasteland for a couple of years now, so it's no surprise that U.S. equity funds as a category are even worse than Canadian equity funds when it comes to the MER value indicator.

A couple of funds did produce excellent results, though. Most notable is the $2.2-billion Investors U.S. Large Cap Value Fund, which had a five-year average MER of 2.96 per cent and a gross return of 9.1 per cent over the same period. That means the fund's MER used up just under one-third of gross returns.

Investors U.S. Large Cap Value has an MER that is well above the category average of 2.56 per cent (this is typical of Investors Group). Still, as you'll see in a moment, this fund justified the fees it charges better than all other big U.S. equity funds.

For example, AGF American Growth Class, MD U.S. Large Cap Growth and CIBC U.S. Index RRSP each had marginal gross returns that were turned into net losses for unitholders after management expenses were applied. The AGF fund had a gross return of 0.14 per cent that became a reported loss of 2.76 per cent after the MER of 2.9 per cent entered the picture.

Several big U.S. equity funds lost a small amount of money over five years even before their MERs were factored in, including Phillips Hager & North U.S. Equity, Royal U.S. Equity, Fidelity Growth American and AIC Value.

Royal U.S. Equity is representative of this group. It had a gross loss of 0.12 per cent, which grew to 2.38 per cent for unitholders after the MER of 2.26 per cent was included. Note the 2.26-per-cent MER here -- it's much lower than average, yet the MER value indicator suggests it wasn't a bargain.

Quite a few global equity funds scored some decent numbers according to the MER value indicator. Top honours go to the $3.3-billion Trimark Fund, where a much lower than average MER accounted for just 22 per cent of five-year returns.

Very respectable numbers were also turned in by Mackenzie Ivy Foreign Equity, where the five-year MER used up just 23.7 per cent of gross returns, as well as Trimark Select Growth at 33.8 per cent and AGF International Value at 38.1 per cent.

Investors Global obliterated 98 per cent of its five-year gross returns with a higher-than-average MER of 2.98 per cent, while Fidelity International Portfolio, BPI Global Equity and CI Global were among the big global equity funds that had meagre gross returns converted to losses after MERs were applied.

Templeton Growth, Canada's largest fund by assets, was marginally in the red over five years even even before the MER.

The past several years have been brutal for equity funds, so don't get too excited if some of your funds score poorly when analyzed using the MER value indicator.

Your best course of action is to put these funds on probation to see whether they make money for you as well as your fund company. If not, there are plenty of funds that can.
Try this at home

Here's how to use the MER value indicator on funds that you own or are considering for your portfolio.
1. Look up the fund's five-year compound average annual return using or The Globe and Mail's Net Worth Monthly section (published the third Wednesday of each month).
2. Using the simplified prospectus for your funds, look up the MER for each of the past four years (you can download fund prospectuses from the Sedar Web site at or Net Worth Monthly will give you your fund's current MER.
3. Add the five-year average MER to the five-year compound average annual returns, then divide the total into the MER and multiply by 100.
4. To get some context on how your funds score, compare their numbers to the funds mentioned in this story. Rob Carrick


Here's a look at how the 10 largest Canadian equity funds by assets did at earning their management expenses with solid returns.

...............................Reported compound..............Percentage of

.................5-yr average...average annual.....Gross......gross return used

Fund................MER..........5-year return.....return*....up by the MER

Ivy Canadian.......2.48%..............+5.41%........+7.89%.......+31.43%

Trimark Select

Cdn Growth........2.48...............+2.66.........+5.14........+48.25

AIC Diversified


Royal Cdn Equity...2.10...............+1.50.........+3.60........+58.33

Fidelity True


Investors Cdn


Investors Summa....2.99...............+0.06.........+3.05........+98.03

AIC Advantage II...2.68...............-4.89.........-2.21...........-

AIC Advantage......2.42...............-5.92.........-3.50...........-

CI Harbour Fund....2.48...............+6.44.........+8.92........+27.80

*Gross return = MER + reported return

© 2007 The Globe and Mail. All rights reserved.

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