TORONTO and OTTAWA -- What they don't tell you about fees
Many investors are surprised at how much they pay in fees to their mutual fund companies - and who gets the money.
An ROB investigation shows that there is often no relationship between mutual fund fees and performance and that many investors pay handsomely for poor returns.
That's one reason why mutual funds have profited even as returns have stagnated or fallen.
A SIX-DAY SERIES CONTINUES TODAY WITH A THREE-PAGE REPORT
Canadians have invested billions of dollars in mutual funds that charge fees that eat up much or all of their returns, an exclusive Report on Business analysis shows.
The ROB review of many of Canada's most popular mutual funds shows that management expenses -- the built-in fees that are automatically deducted from the price of each mutual fund unit before the value is published -- can often obliterate most of a fund's returns.
The review found that at least $32.7-billion is invested in funds in Canada that lost money for investors over the five years to March 31, even though the fund companies made tens of millions of dollars in revenue from the fees. Another $21-billion-plus is invested in funds where more than half of the gross returns of the fund went to pay fees, the ROB analysis shows.
The bottom line? The ROB review shows that, in too many cases, investors are not getting good value for the fees they are paying.
"What's interesting to me is that in most products, the more you pay, the more you get," says Brian Tang, president of Vancouver-based Fundamental Research Corp., who did his own study last year on management expense ratios (MERs) of Canadian equity funds. "With these funds, it appears that is not the case."
The Globe's review looked at 615 mutual funds in the major equity, bond and balanced categories to determine the value investors receive for the fees they pay their fund companies. The measuring was done using the Fee-to-Performance Value Indicator, which looks at how much of a fund's gross returns are used by a fund company to cover costs ranging from manager salaries and research to commissions for dealers and advisers who sell funds. The data, prepared by Globefund.com, looked at fund returns for the five years to March 31.
The value indicator uncovered a mix of terrific fund values, mediocrities and outright disasters.
The worst of the worst were the 152 funds in the review that lost money in the past five years, including the $1.1-billion AGF American Growth Class, the $547-million BMO International Equity Fund and the $612-million PH&N U.S. Equity Fund. It's not possible to calculate a negative value score, but these funds can accurately be described as delivering no value at all for their fees.
One fund that offered poor value based on an actual score was the $289-million Investors Canadian Enterprise Fund. Its value score of 88.6 means that fees chewed up almost $9 of every $10 it earned over the past five years.
This fund's value score uses an MER of 2.95 per cent, although Investors Group created a new version of this fund a year ago with a lower MER of 2.75 per cent. Even at that level, the fund's MER is near the higher end for its category.
Other funds that generated more in fees than they did in returns were Ethical Growth, a $463-million socially responsible mutual fund with a value score of 62.7, and the $843-million Altamira Equity Fund, a former fund industry superstar with a score of 55.6.
The median value score for all funds in all categories measured was 25, meaning about 25 per cent of returns went to cover fees. Among the funds easily beating the median -- most of them notable for their low MERs -- was the $2.2-billion PH&N Dividend Income Fund, offered by Vancouver-based fund company Phillips Hager & North. With an MER that is less than half the average of its peers, this fund managed a value score of 7.4.
Not all the top values were low MER funds, however. The $365-million Sprott Canadian Equity Fund has an MER about a full point higher than the typical big fund in this category, yet it managed a value score of 7.4 based on outstanding five-year returns.
The ROB study also assigned scores to fund companies based on their funds used in the study. AIC Ltd., Investors Group and AGF Funds fared worst, with PH&N, Franklin Templeton Investments and BMO Investments faring best.
PH&N has among the lowest MERs in the fund industry, in large part because it pays zero commissions and fees to dealers. With a majority of funds, roughly a full percentage point of the MER is accounted for by compensation to dealers and financial advisers to sell funds. On the other hand, PH&N and some other low-MER families have minimum initial investments as low as $5,000 or as high as $100,000, so may not be attractive for everyone.
Investor advocates say data on MERs and performance demonstrates why it is so important for investors to figure out the fees they pay for the funds they own -- and to understand that there are also costs not included in the MER, such as trading commissions.
Ken Kivenko, a spokesman for the Small Investor Protection Association, says many surveys have found that a majority of mutual fund investors don't realize they pay any fees at all, because they are built in to the cost.
Mr. Kivenko says it is surprising that some mutual funds tend to attract billions of dollars despite their uncompetitive fees, but he says he thinks this is because many investors don't know the details of what they are buying. Although the MER is disclosed in the prospectus for the fund, many investors don't read the lengthy document.
"It's a very inefficient market," he said. "Many people are smaller, retail investors. They are not the most financially literate investors."
Other individual investors who own mutual funds have come to similar conclusions about MERs.
Jason Sorby says it was three years ago that he had what he calls his "MER awakening," waking up to the link between the management expense ratios on his funds and their returns.
"I realized I was sitting on a bunch of funds that were performing average at best, so I started doing my research." said Mr. Sorby, a 34-year-old engineer at a Winnipeg refrigeration firm.
He concluded that the fees were biting too deeply into returns. The next step was to seek out funds with lower MERs. "Less money being taken off the top over the long term has got to help," Mr. Sorby said. "It gives the manager a leg up over some of the funds where they're charging more."
But experts in and around the fund industry have long played down the importance of choosing funds based on their MERs.
Ian Filderman, director of mutual funds for Bank of Nova Scotia's wealth management arm, says the MER is most important in sectors such as money market and bond funds, where there are limited opportunities for managers to earn their keep with shrewd decision making.
"As you move into the equity world, though, it's far less meaningful," Mr. Filderman said. "When you're investing in an equity fund, the greatest source of value added comes from the managers -- their investment style, the risks they're willing to take in the portfolio, how well they're rewarded for those risks. It's the core fundamentals of asset management that ultimately determine most of the outcome."
Scott Mackenzie, president of independent fund rater Morningstar Canada, said laggard funds that don't justify their fees are easy to find, but he believes the industry as a whole provides good value for the MER dollars paid by investors. He describes this value in terms of professional management, portfolio diversification and features such as systematic contribution programs, where people can invest small amounts on a regular schedule.
"Getting that for an MER of somewhere around 2.5 per cent is actually not a bad deal at all," Mr. Mackenzie said.
Moreover, Murray Taylor, president and CEO of Investors Group, says it is unfair to compare his firm's MERs to those of dissimilar fund companies. Unlike discount fund companies such as PH&N or retail banks, he said Investors Group provides more full-service financial planning to its clients, which costs more. He says Investors Group has MERs "in the middle" of the pack of similar fund companies.
It is a more expensive business model than "running into a bank and ordering something across the counter," he said, adding that unitholders are not fixated on MERs, and are generally highly satisfied with the service they receive.
David Feather, president of Mackenzie Financial Services Inc., said his firm has been working with the advisers who sell its products to hone a message about the value that investors receive for the fees they pay. This includes the expertise of the adviser, the access to products and services offered by the fund company, and the performance of the funds. In Mackenzie's case, a recent analysis by the company showed that its nine biggest funds all outperformed their peer groups and their benchmarks over the previous seven years.
"We think [value] is probably one of the bigger issues to Canadians right now. We've really been emphasizing this, more so than we have been on a product push."
However, Steve Geist, president of TD Mutual Funds, argues that it is important to compete on MERs for those investors who are price conscious. He said TD's lower MERs in key fund categories such as its money market and bond funds are a key factor in their growth.
He said his funds' lower MERs are not entirely a result of the lower cost structure of a bank. He said TD has also made a strategic decision to keep the MERs low as a competitive factor. The huge TD Canadian Bond fund has an MER of 1.07 per cent, compared with an industry average of 1.83 per cent.
"It's the way we've designed the products," Mr. Geist said. "I think you have to be consciously prepared to accept a lower profit margin."
Indeed, profit margins cannot be ignored as a factor in the level of fees charged by funds. The mutual fund industry has been extremely profitable, even during the period of market turmoil from late 2000 to 2002. Industry giant Investors Group, for example, has seen its profit grow at a compound annual rate of 24.3 per cent over the past five years.
Dan Hallet, a Windsor, Ont.-based independent mutual fund analyst, says MERs should matter greatly to investors, because they are the only factor affecting future performance that investors can know with certainty when they buy a fund. As a result, he says lower expenses are a key factor in any investment decision.
Still, Mr. Hallet warns that investors cannot compare the expenses of completely dissimilar funds.
Some funds are indeed more expensive because they build in a fee that is paid to the adviser who sells the fund, as compensation for providing a service to investors who want the help. He says many investors need help with their money, and should expect to pay something for the service.
But, he adds, he won't personally invest in funds with MERs higher than their peers.
"It would be hard for me to justify paying 2.5 per cent [as an MER] even for a really highly skilled manager, when I can pay 1.5 per cent for a really highly skilled manager in the same asset class," he says. "One is not necessarily clearly superior to the other."
There have been several detailed studies on the importance of MERs over the years, and a frequent conclusion is that they matter a lot.
One such study was just completed by Gene Hochachka, who until recently was a quantitative analyst for Phillips Hager & North. To get a fix on how MERs affect fund performance, he looked at rolling rates of return for all funds over one-, three- and five-year periods from 1986 to 2003.
Mr. Hochachka found that on average, each percentage point of extra MER leads to a loss of one percentage point in performance, despite any differences in fund managers' abilities. Put another way, it's difficult for the skill of a fund manager to overcome the dead weight of a higher MER.
For this reason, Mr. Hochachka believes investors are better off emphasizing low MERs than they are in seeking managers who will deliver big returns regardless of fees.
"If you have a way of choosing each year's top-performing fund for a particular category, run with that," he said. "But in the absence of such a method -- and there's none yet that I've been able to find -- your best bet is to go with a low-fee fund."
Indeed, much research has shown that funds with higher MERs often have lower returns because of the impact of the high fees.
Mr. Tang at Fundamental Research, for example, looked at 116 Canadian equity funds in a study last year, and found that funds with above-average MERS had below-average performance over the previous 10 years, both in terms of underperforming the S&P/TSX index and underperforming the average of their peers.
"Contrary to logic, when purchasing mutual funds, it is not necessarily the case that the more you pay the better-quality product you receive," he concluded.
On the other hand, a study by John Chan of FundMonitor.com found that higher MERs could be worth the money in specialized funds where the expertise of the manager might make more difference. Of the fund categories he studied, global science and technology funds and emerging markets funds were the only ones where there was a positive correlation between expenses and returns.
"If they put more money into doing research, or travelling, or doing due diligence, you find it does pay off sometimes," Mr. Chan said.
But, he warned, it was still a "fairly weak" positive correlation even in specialty funds. "So it's not that strong a relationship," he added. "In general, you will save money off lower MERs."
But investor advocates like Mr. Kivenko believe customers will be slow to take charge of MERs until more of them understand the costs they are paying.
To accomplish that, he believes the mutual fund industry should put specific information about fees on investors' account statements. Mr. Kivenko said the fees should be disclosed in dollars and cents for each investor's account, not just as a generic percentage, so that investors know exactly how much they are personally paying each year.
It is a topic that has been tackled in a concept paper published by the Ontario Securities Commission, which has proposed a new Fair Dealing Model to change most aspects of the relationship between the financial services industry and its clients. Among the proposals for change, the OSC paper calls for full transparency of all costs paid by mutual fund investors, including the actual amounts paid by an investor each year.
But Mr. Kivenko, who is a member of the Fair Dealing Model's investor reporting working group, says there is opposition to the details of the proposal from some in the fund industry, who complain about incurring additional costs. So the outcome for investors is far from guaranteed.
"They don't want to do it," he said. "The industry is fighting. A few companies are supporting it, but most of them don't want that kind of transparency."
The best and the worst
A lower fee-to-performance value indicator suggests a better deal for investors, with fees eating up less of a fund's returns. Includes only funds with more than $200-million in assets under management.
Top 20 funds
Fund name: Company name: Annualized Five Year Return: MER: Return + MER: Fee-to performance value indicator: Net assets ('000):
Ferique Equity: Gestion FERIQUE: 8.89%: 0.62%: 9.51%: 6.52%: $235,125
PH&N Dividend Income: Phillips, Hager & North Inv Mgmt: 14.67%: 1.18%: 15.85%: 7.44%: $2,169,861
Sprott Canadian Equity: Sprott Asset Management Inc.: 42.89%: 3.45%: 46.34%: 7.44%: $364,950
PH&N Bond: Phillips, Hager & North Inv Mgmt: 6.99%: 0.60%: 7.59%: 7.91%: $2,372,474
Sceptre Equity Growth: Sceptre Investment Counsel Ltd.: 19.01%: 1.72%: 20.73%: 8.30%: $250,920
Quebec Professionals Cdn. Equity: Fonds des Professionnels Inc.: 9.72%: 0.97%: 10.69%: 9.07%: $242,244
Renaissance Canadian Income Trust: CM Investment Management: 18.17%: 1.90%: 20.07%: 9.47%: $715,185
Scotia Canadian Dividend: Scotia Securities Inc.: 10.95%: 1.18%: 12.13%: 9.73%: $1,122,715
RBC O'Shaughnessy Canadian Equity: RBC Asset Management Inc.: 14.81%: 1.63%: 16.44%: 9.91%: $673,152
CI Signature High Income: CI Mutual Funds: 14.56%: 1.61%: 16.17%: 9.96%: $1,718,248
ABC Fundamental Value: ABC Funds: 17.89%: 2.00%: 19.89%: 10.06%: $356,920
Elliott & Page Growth Opportunities: Elliott & Page Ltd.: 24.65%: 2.84%: 27.49%: 10.33%: $273,786
PH&N Canadian Equity: Phillips, Hager & North Inv Mgmt: 9.73%: 1.16%: 10.89%: 10.65%: $1,423,579
Legg Mason Canadian Active Bond: Legg Mason Canada Inc.: 6.03%: 0.72%: 6.75%: 10.67%: $459,899
CIBC Monthly Income: CIBC Securities Inc.: 10.06%: 1.21%: 11.27%: 10.74%: $2,317,849
Beutel Goodman Canadian Equity: Beutel Goodman Managed Funds Inc.: 11.24%: 1.36%: 12.60%: 10.79%: $265,841
RBC Canadian Index: RBC Asset Management Inc.: 6.75%: 0.84%: 7.59%: 11.07%: $431,199
Saxon Stock: Saxon Funds: 14.93%: 1.87%: 16.80%: 11.13%: $225,772
TD Canadian Index: TD Asset Management Inc.: 6.69%: 0.85%: 7.54%: 11.27%: $687,330
RBC Monthly Income: RBC Asset Management Inc.: 9.45%: 1.21%: 10.66%: 11.35%: $3,092,795
Bottom 20 funds
Investors Canadian Enterprise*: Investors Group: 0.38%: 2.95%: 3.33%: 88.59%: $288,600
Clarica Canadian Diversified: CI Mutual Funds: 0.81%: 2.70%: 3.51%: 76.92%: $462,854
Ethical Growth: Ethical Funds Inc.: 1.46%: 2.46%: 3.92%: 62.76%: $463,489
Desjardins Select Canadian Balanced: Fonds Desjardins: 2.44%: 3.14%: 5.58%: 56.27%: $291,307
Talvest Cdn. Asset Allocation: Talvest Fund Management: 2.06%: 2.61%: 4.67%: 55.89%: $479,686
Altamira Equity: Altamira Investment Services Inc.: 2.17%: 2.72%: 4.89%: 55.62%: $843,295
IG Sceptre Canadian Equity*: Investors Group: 2.69%: 3.22%: 5.91%: 54.48%: $297,300
Desjardins Canadian Balanced: Fonds Desjardins: 1.90%: 2.19%: 4.09: 53.55%: $376,901
Scotia Total Return: Scotia Securities Inc.: 2.32%: 2.56%: 4.88%: 52.46%: $461,512
Investors Asset Allocation*: Investors Group: 3.00%: 3.20%: 6.20%: 51.61%: $1,667,800
Talvest Cdn Equity Growth: Talvest Fund Management: 2.60: 2.76: 5.36: 51.49: $411,721
Ethical Balanced: Ethical Funds Inc.: 2.34%: 2.42%: 4.76%: 50.84%: $428,536
TD Balanced: TD Asset management Inc.: 2.45%: 2.33%: 4.78%: 48.74%: $838,979
CIBC Balanced: CIBC Securities Inc.: 2.89%: 2.43%: 5.32%: 45.68%: $1,039,267
CI Canadian Asset Allocation: CI Mutual Funds: 3.07%: 2.55%: 5.62%: 45.37%: $315,168
Desjardins Canadian Equity: Fonds Desjardins: 2.63%: 2.19%: 4.82%: 45.44%: $303,142
Desjardins Diversified Moderate: Fonds Desjardins: 2.66%: 2.04%: 4.70%: 43.40%: $250,931
IG AGF Canadian Balanced*: Investors Group: 4.28%: 3.22%: 7.50%: 42.93%: $513,200
Renaissance Canadian Growth: CM Investment Management: 3.33%: 2.48%: 5.81%: 42.69%: $270,793
AIC Diversified Canada: AIC Ltd.: 3.34%: 2.43%: 5.77%: 42.11%: $3,246,935
*Investors Group has created a new version of these funds with an MER that is lower by about 0.2 of a percentage point.
Canada's 15 largest mutual fund companies
The companies show a wide range of value for investors compared to the fees they pay. A lower value indicator suggests a better deal for investors, with fees eating up less of a fund's returns.
Ranked by value indicator
Fund company: No. of funds used in calculation: Average 5-year return of funds used in calculation: Fee-to-performance value indicator: Assets of funds used in fee-to-performance indicator calculation
AIC Ltd.: 1: 3.34%: 2.43%: 42.11%: $3,246,935%
Investors Group*: 23: 5.44%: 2.88%: 38.62%: $29,078,564
AGF Funds Inc.: 7: 6.94%: 2.55%: 32.35%: $7,969,032
CI Mutual Funds: 29: 7.18%: 2.53%: 29.03%: $17,571,494
CIBC Securities Inc.: 13: 5.99%: 2.07%: 28.59%: $7,411,171
Dynamic Mutual Funds Ltd.: 17: 7.41%: 2.62%: 28.07%: $4,436,236
Scotia Securities Inc.: 7: 5.98%: 1.72%: 25.47%: $6,272,810
Mackenzie Financial Corp.: 22: 7.84%: 2.42%: 25.35%: $18,399,034
TD Asset Management Inc.: 17: 7.17%: 1.80%: 22.05%: $14,672,647
Fidelity Investments Canada Ltd.: 7: 8.91%: 2.37%: 21.77%: $14,693,942
RBC Asset Management Inc.: 13: 7.55%: 1.82%: 21.56%: $25,202,891
AIM Trimark Investments: 10: 9.02%: 2.15%: 20.71%: $14,206,755
BMO Investments Inc.: 7: 8.13%: 1.89%: 19.85%: $8,549,756
Franklin Templeton Investments: 8: 8.74%: 1.67%: 17.39%: $1,561,219
Phillips, Hager & North Investment Management Ltd.: 8: 7.68%: 1.01%: 12.15%: $10,762,223
*Investors Group introduced lower MER versions of some of its funds a year ago, which together would reduce its fee-to-performance score to 37.45.
Fee-to-performance value indicator is based on funds with positive five-year returns as of March 31, 2004; funds with negative five-year returns were not included in the calculation; Study excludes funds with less than $10-million in assets; Fund categories included in data for chart are: Canadian equity, Canadian dividend, Canadian balanced, Canadian tactical asset allocation, Canadian income trust, Canadian bond. Average are not asset-weighed.
A lower fee-to-performance value indicator suggests a better deal for investors, with fees eating up less of a fund's returns.
The data in the Report on Business study includes only funds with five-year track records and positive returns. Because the data excludes newer funds and funds with negative returns, the averages shown may differ from the broader industry averages when all funds are included.
Asset class: Number of funds included: Average 5-year annualized return: Average MER: Average fee-to performance value indicator
Canadian Balanced: 109: 5.60%: 2.19%: 30.45%
Canadian Bond: 66: 5.51%: 1.54%: 22.14%
Canadian Dividend: 30: 10.04%: 2.07%: 17.84%
Canadian Equity: 146: 8.51%: 2.44%: 26.84%
Canadian Equity (Pure): 26: 8.04%: 1.76%: 21.78%
Canadian Income Trusts: 10: 15.63%: 2.04%: 13.30%
Cdn. Tactical Asset Allocation: 19: 4.89%: 2.35%: 36.20%
The ROB data on five-year average returns and average MERS for funds that invest outside Canada vary significantly from industry norms because the Globe's calculation included only funds with positive five-year returns. Many global, international and U.S. funds had negative returns over the past five years, and are not included in the averages.
**Asset class: Number of funds included: Average 5-year annualized return: Average MER: Fee-to-performance value indicator: Average 5-year return of all funds including negative returns: Average MERs of all funds including negative returns
Global Equity: 37: 6.11%: 2.73%: 41.62%: 0.3%: 2.98%
International Equity: 8: 3.10%: 2.07%: 44.09%: -2.1%: 2.70%
U.S. Equity: 12: 5.31%: 2.37%: 42.30%: -5.0%: 2.78$
Mutual funds with negative five-year returns have delivered investors the worst value for the fees charged. This chart shows some of Canada's worst-performing mutual funds, and the management expense ratios (MERs) they charge.
AGF American Growth Class.....-11.01%......3.08%....$1,094,321
MD U.S. Large Cap Growth.......-8.49..........1.36.........508,312
BMO International Equity...........-6.37..........2.58..........547,372
PH&N U.S. Equity...................-6.16..........1.18.........612,207
TD International Equity..............-5.76...........2.84.........507,677
Fidelity Growth America.............-4.87...........2.61.........703,200
BPI Global Equity.....................-4.57..........2.53..........736,818
CIBC U.S. Equity index..............-3.52..........0.96...........557,230
AIM Global Theme Class............-3.44..........2.83...........555,537
RBC U.S. Equity......................-2.73..........2.19.........1,240,256
TD Global Select.......................-2.63..........2.59...........626,633
Fidelity International Portfolio.........-2.18..........2.59........3,779,347
Mackenzie Select Managers..........-1.87..........2.57...........690,676
Templeton International Stock.......-1.26...........2.98.........3,170,834
AIC Advantage II......................-0.58..........2.69.........1,735,029
Clarica Canadian Blue Chip...........-0.52..........2.74............530,721
Mutual fund management fees are shared among several recipients. The Mackenzie Ivy Canadian Fund, for example, has a 2.51 per cent management expense ratio. With a $10,000 investment, the $251 fee breaks down like this each year:
Operating expenses: $35
To the seller (broker, financial planner, etc): $98
To the fund company: $102
SOURCE: MACKENZIE FINANCIAL CORP.
What You Pay
Here are the typical fees paid in one year on an average Canadian mutual fund portfolio of $80,000, using average management expense ratios for each asset class:
Fund category.....for category....Investment....MER paid
Over the long run
The difference between a higher or lower Management Expense Ratio can have a huge impact on your investment return over the long term. Take the following example of a $10,000 investment of 20 years*.
Gross annual return before MER...............9.5%............9.5%
Net annual return after MER.....................7.0%............8.0%
Profit before fees...............................$51,416...........$51,416
Profit after fees.................................$27,847...........$35,998
+ original investment............................$10,000...........$10,000
= final investment value.........................$37,847..........$45,998
*Assuming no-load funds that charge no other fees
SOURCE: MUTUAL FUND FEE IMPACT CALCULATOR AT WWW.INVESTOR.CA
Rapid trading in mutual funds bears marks of market timing
Mechanics of market timing, who does it, who doesn't and why
Proposed rules for fund governance favour industry, critics say
Not all fund managers have suffered the same pain as investors
Fees and fund performance don't always go hand-in-hand
Segregated fund fees on the rise
Dos and don'ts for the investors
On the Web
Follow the mutual fund series this week on our website http://www.globeandmail.com
© 2007 The Globe and Mail. All rights reserved.
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