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Mutual Fund News

High MERs needn't be a dirty little secret

Fund fees can add up. But sometimes, you get what you pay for, DALE JACKSON writes

There's a saying in the mutual fund industry that you won't see on promotional material this RRSP season: Mutual funds aren't bought, they're sold.

To get a true understanding of what that means, you first need to understand the fee structure imposed by the Canadian mutual fund industry.

Many retail investors are familiar with the management expense ratio, the per cent charged annually on your total investment in a mutual fund. The MER goes toward paying the fund's operating expenses, ranging from trading fees to salaries and commissions for staff, to those slick brochures you get in the mail.

The MER is subtracted from the fund's total return before it is posted. Mutual fund companies are required to display the MER prominently when providing performance details. However one detail tucked away within the MER is the trailer fee -- the portion that goes toward paying the person who sells you the fund, which in most cases is a financial adviser.

Trailer fees vary from fund company to fund company, which inevitably raises a question about whose best interest is being served when a fund is sold, or bought. Is a financial adviser recommending a fund because it's best for the client or because it has a high trailer fee?

Glorianne Stromberg, a retired securities lawyer, former commissioner of the Ontario Securities Commission, and author of several studies on mutual fund fees, says providing incentives for financial advisers is like letting the fox guard the henhouse. "The system doesn't allow them to act for anything but their own self interests," she says.

Financial advisers or mutual fund dealers receive compensation through trailer fees, and front- and back-end loads. But while loads are a one-time charge, trailer fees are charged annually.

In theory the investor pays a financial adviser to provide advice on a mutual fund every year the fund is held. If the trailer fee is 1 per cent, that's a $100 charge for every $10,000 invested. "I think trailer fees should be eliminated" says Ms. Stromberg. "Most people would be better off to pay a fixed fee for [financial] advice, like a lawyer."

Ms. Stromberg says trailer fees are fairly specific to Canada, which helps explain why fees on Canadian mutual funds are among the highest in the industrialized world. The average MER among equity and balanced funds in Canada is estimated at 2.6 per cent.

The industry group representing Canadian mutual fund companies disputes any assertions that Canadians pay more for mutual funds. "Their comparisons are hard to follow," says Joanne De Laurentiis, president & CEO of the Investment Funds Institute of Canada.

Ms. De Laurentiis also dismisses claims that the trailer-fee structure could encourage financial advisers to recommend funds with the highest commissions. "Trailer fees are there to encourage advisers not to have individuals switch back and forth," she says.

To help investors understand and save on fees, the Ontario Securities Commission has established the Investor Education Fund, which provides an online fee calculator (go to http://www.investored.ca). Fees are calculated from all sources. As an example, a $1,000 investment with a return of 8 per cent annually over 20 years would produce a profit of $3,661 without fees - but only $1,807 after the 2.6 per cent MER.

"Knowing the true costs will allow you to make a more accurate assessment of return expectations," says Investor Education Fund president Tom Hanza.

As with any product, the onus is on consumers to do their homework. Websites (such as GlobeFund.com) can rank funds in any given asset class according to fees.

The highest MER for an open-ended Canadian equity fund belongs to the DMP Canadian Value Class fund from Goodman and Company Investment Counsel Ltd. at 4.11. The least expensive open-ended fund is United-Canadian Equity Value Pool at 0.21 per cent.

It's important to keep in mind that the cheapest funds aren't necessarily the best funds. The DMP Canadian Value Class fund returned more than 28 per cent last year even after the 4.11 per cent MER was subtracted - nearly doubling the average Canadian equity fund and the TSX. The United-Canadian Equity Value Pool fund, on the other hand, returned less than 10 per cent in 2006.

Investors should consider other criteria, including management experience, investment style, risk and past returns. In some cases fees are "performance based" and investors could wind up paying their manager 20 per cent for an investment that doubles in one year.

And some funds simply cost more to run. International equity funds have higher MERs to compensate for managing a portfolio on a global level. Funds that spread themselves thin often turn to outsourcing management more familiar with a specific region.

Also, some segregated funds have MERs in excess of 10 per cent because they offer attributes similar to life insurance policies, including a guarantee on all or part of the initial investment.

The high costs associated with actively managed mutual funds have boosted the popularity of exchange traded funds. ETFs, also known as passively managed funds, track indices according to country or sector. They trade on exchanges just like stocks and the only cost to the investor is often trading fees when they are bought or sold.

However, there is a tradeoff when it comes to ETFs versus mutual funds. Investors are exposed to the whim of the broader markets, without the benefit of an experienced portfolio manager to steer clear of danger.

Dale Jackson is a producer at Report on Business Television.

Good funds at a fair price

Fund 5-year return MER
Bissett Small Cap-F18.8%1.77%
RBC O'Shaughnessy Canadian Equity 14.5%1.50%
BMO Dividend 13.8%1.73%
Scotia Canadian Dividend13.1%1.64%
Altamira Special Growth 12.7%1.92%
TD Dividend Income12.6%2.00%

© 2007 The Globe and Mail. All rights reserved.

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