A favourite piece of ammunition used by mutual fund bashers is a dud.
Contrary to popular opinion, we are not getting hosed on fund fees, compared with what Americans pay.
"There is a widespread perception that the Canadian-American expense ratio gap is large and widening," says a report by the independent research firm Investor Economics. "But a closer inspection of the trends and the key differences in those calculations suggests this may not be the case."
Canadian fund investors do pay more than Americans, but the gap isn't nearly as large as some people imagine. In fact, the differential isn't out of line with all the other products and services that are cheaper south of the border.
Are Canadian fund companies off the hook, then, when it comes to fees? Hardly. There are still way too many funds that charge way too much for way too little performance.
This is the reason to get mad at the fund industry for the fees it charges, not the fact that fees are somewhat higher here than south of the border.
People sometimes get a skewed picture when comparing fees, because fund management expense ratios (MERs) in Canada are broadly inclusive packages that contain the cost of paying advisers and their firms for services provided to clients who buy funds.
In the United States, these so-called distribution costs are broken out separately as 12b-1 fees, the Investor Economic report explains. The report was issued to the firm's paying clients in July, but a copy was recently made available for this column.
Differing fee structures are a major reason why the MER for U.S. equity funds sold in the United States was about 1.05 per cent in 2002, while the comparable number for Canadian equity funds was 2.36 per cent. While U.S. investors paid a median 1.32 per cent for a world stock fund, Canadian investors paid about 2.41 per cent.
Investor Economics says 12b-1 fees range from as little as 0.25 per cent to 1 per cent. Add 0.75 to 1 per cent back to those low median U.S. fund MERs and all of a sudden the Canadian funds don't look quite so comparatively expensive.
An obvious objection here would be to say, all right, what if I buy a U.S. fund that happens to have 12b-1 fees of 0.25 per cent. In that case, I'd be way ahead of the game.
As outlined in the Investor Economic report, the problem here is that funds with such a low 12b-1 fee are sold with an up-front commission that starts at 5.5 per cent for purchases of up to $25,000 and eases to zero once you invest $1-million. These are non-negotiable commissions, Investor Economics says.
In Canada, you might well be able to buy the same type of fund with an up-front commission of zero to 2 per cent, or a deferred sales commission that only kicks in if you sell within six or seven years of buying.
It's all quite confusing, which is why Investor Economics concludes that the Canadian MERs in its comparison should be cut at least 0.75 to one percentage points to fairly compare them with U.S. fees.
"After this adjustment, Canadian MERs still exceed the American pricing, but by a much lower margin."
And what of that remaining cost differential? To some extent, you can explain it as being a result of the fact that U.S. fund companies have a market of 290 million people, while Canadian companies have a pool of 31 million.
Another factor to consider is that the median U.S. fees are skewed a little bit by index fund giant Vanguard, which is a low-cost leader in the fund industry.
Still another explanation is that Americans are much bigger consumers of no-load funds, which tend to have lower fees because they don't need to pay sales commissions to advisers.
A final point, one that Canadian fund companies raise when confronted on the matter of fees, is the cost of this country's ridiculously fragmented regulatory system. According to one estimate, filing documents with multiple provincial and territorial securities commissions instead of one national agency bloats management expenses as much 0.1 to 0.25 of a percentage point.
Lest Canadian fund companies get too comfortable here, let's keep in mind that U.S. fund companies face criticism about the fees they charge. New York State Attorney-General Eliot Spitzer has described fund fees as being "grossly out of control."
Mr. Spitzer may have something to say about what happens with fund fees in his country, but here in Canada it's up to individual investors to look after themselves. That's fine because there are all kinds of low-cost fund options out there, including index funds, no-load fund families and some mainstream funds that happen to be reasonably priced.
Want to know the best way to bash the fund industry over the fees it charges? Just ignore overpriced junk funds.
© 2007 The Globe and Mail. All rights reserved.
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