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TERs: Another fund cost to consider

The trading expense ratio can often be a drain on your returns, ROB CARRICK writes

You can't fully understand the cost of owning mutual funds until you familiarize yourself with a small nugget of information that only became available to investors just over a year ago.

It's called the trading expense ratio, or TER, and it tells you how much your funds are spending to cover the cost of brokerage commissions for buying and selling stocks. People typically determine how much it costs to own a fund by looking at its management expense ratio, or MER. But trading expenses can be a key component of fund costs, and they're not reflected in the MER.

Fund companies have been required to provide TER data in their semi-annual performance reports to unitholders for about a year now, but little use has been made of it to date. Websites such as and haven't yet included TERs in their online fund profiles, and investors have been predictably oblivious. Cost awareness isn't a strong suit among Canadian investors, who pay some of the highest mutual fund ownership fees in the world.

Though obscure, TERs matter. They tell you not only about costs you're bearing as an investor, but also a little something about the managers of your fund and the job they're doing. A tiny TER suggests you've got a conservative manager who takes a buy-and-hold approach, whereas a higher TER suggests a more aggressive approach. If you have a fund with a high TER, you'll want to make sure all that trading is generating some value through good returns.

This edition of the Portfolio Strategy column is all about mutual trading costs as reflected in the TER, and what they mean to investors who buy mutual funds. Before we get to the details, let's look at some background on fund fees.

The usual fee measuring stick is the management expense ratio, which combines almost all the costs of running the fund and expresses them as a percentage of assets. If a mutual fund has an MER of 2.5 per cent, it means that the fund company behind it is scooping 2.5 percentage points off its gross returns before reporting net gains to unitholders.

TERs are similar to management expense ratios in that they express total trading costs as a percentage of assets. Add the TER of a fund to the MER and you pretty much have an all-in accounting of the costs of owning it.

To get a feeling for TERs, I looked at numbers drawn from the 25 largest equity, balanced and monthly income funds, the 25 best-performing funds in those categories over the past 10 years and the 25 worst-performing funds over the same period. The TER data were taken from the most recent semi-annual fund performance reports offered by fund companies and covers 2006 and previous years.

Some important lessons for investors who buy mutual funds emerge from all this data, one of them being that people who own hugely popular funds with billions in assets don't need to sweat the TER.

Jumbo-sized mutual funds tend to be fairly conservative in style, which means they don't do a lot of jumping in and out of stocks. The net result is that their trading expense ratios are minimal. So minimal in fact that, as a rule, you can pretty much ignore TERs if you own funds like Investors Dividend, RBC Balanced and CIBC Monthly Income.

The average TER for the 25 most widely held equity, balanced and monthly income funds was 0.06 per cent. Put another way, gross returns from these funds were reduced by an inconsequential 0.06 of a percentage point to cover trading commissions.

There were several funds with TERs as low as 0.02 per cent last year, including Investors Dividend, the largest mutual fund in the land with $13.6-billion in assets. The heftiest TER among the 25 largest funds was owned by CI Signature Select Canadian, at 0.19 per cent.

While you can ignore the TER of mega-funds, do not assume the MER is a bargain because sometimes it's not. Take Investors Dividend, for example. At 2.71 per cent, the fund charges a huge premium over the likes of RBC Canadian Dividend at 1.72 per cent and BMO Dividend at 1.73 per cent.

High MERs are generally a bad thing in a mutual fund, but what about high trading expenses?

Examining the TER data for both the best and worst performers of the past 10 years shows that investors really do need to check the TER of any aggressive equity funds or sector funds they own or are thinking of buying. High trading expenses are part of the problem with some of these funds, while others seem to thrive off them.

Consider the Front Street Special Opportunities Canadian Fund, which has an amazing 10-year average annual return of 20.8 per cent. The TER for this fund last year was a hefty 0.62 per cent, but few investors are likely to care much.

A less clear-cut case is Dominion Equity Resource, which had a TER of 0.81 per cent last year and 0.95 per cent in 2005. This fund has produced a stellar average return of 15.3 per cent annually over the past decade, but it's suffering these days and has lost 22.4 per cent in the past year. Active trading has certainly helped this fund over all, but it's a drag on returns right now.

Both of these funds highlight another TER lesson -- when you combine this measurement with the MER, you often get a hefty combined fee load for investors. If you add Dominion Equity's MER of 2.55 per cent to its most recent TER, you end up at 3.36 per cent. Don't buy this long-term star without considering the high cost of ownership.

A classic example of a fund with a high TER and bad results is AGF Managed Futures, a volatile specialty fund that lost an average annual 19.5 per cent over the past decade. Combine this fund's TER of 1.86 per cent with the MER of 4.11 per cent and you have a massive drag on returns of 5.97 percentage points.

Another fund where high trading costs are part of the problem is Talvest Asia, with TERs over the past five years ranging from 0.37 per cent last year to 2.81 per cent in 2003. The five-year average annual return for this fund is 5.73 per cent, compared to a category average of 7.2 per cent.

A couple of final TER lessons:

Low TERs are a feature of many good funds, but they aren't automatically a virtue. There are some awful funds that have moderate or even low trading expenses.

TERs can fluctuate. Try to get a multiyear picture where possible and remember that trading costs may temporarily spike higher if a new manager takes over a fund and flushes a lot of the existing stocks.

Sector funds often have high TERs. These funds often have high MERs, too, which means they can be pricey.

TER data highlight the value of Canadian dividend funds. The typical fund in this category has minimal trading expenses and a low MER -- no wonder returns are often so good.

Many fund investors ignore MERs, which means they're also going to overlook the less important matter of trading expenses. The shame of it is that TERs offer some real insight into how a fund works. If you want to make better investing decisions, take note.

Mysteries of the TER

Here's a primer on the importance of the trading expense ratio, or TER, which measures how much a fund spends on stock-trading commissions.

What is the TER? The total amount of money spent on commissions expressed as a percentage of assets in the fund.

How does it compare with the MER? The management expense ratio measures virtually all other expenses associated with running a mutual fund as a percentage of assets.

So what's the total cost of fund ownership? The MER plus the TER.

How does the TER affect returns? Like the MER, the TER comes off a fund's gross returns and reduces what's available to investors (net returns = gross returns - (MER + TER).

Where are TER data reported? You'll find data for previous years in the semi-annual management performance reports that mutual fund companies produce and make available on their websites (they're also on

Why have I never heard of the TER? Fund companies have only been required to disclose this information to investors for a little over a year.

What's a typical TER? The average for the 25 largest equity, balanced and monthly income funds by assets is 0.06 per cent (the highest in the group is 0.19 per cent and the lowest is 0.02 per cent), while aggressive equity funds can have TERs of 0.5 to 3 per cent.

How important is the TER? It's not a big concern if you own a conservative fund that uses a buy-and-hold approach, but it can certainly have an impact on the returns of more aggressive funds that do a lot of trading.

Is it better for a fund to have a low TER than a high one? A low TER is less of a drag on returns than a high one, but there are poor-performing funds with minimal trading expenses and consistently good funds with high TERs. Investors must judge for themselves.

Expensive trading

If a mutual fund holds stocks in its portfolio, it has to pay brokerage trading commissions. Who foots the bill? You, the investor, through expenses that are charged against a fund's returns. To find out the cost of these trading expenses, check the trading expense ratio, or TER, found in fund company semi-annual performance reports. Here are some different groupings of mutual funds, along with their TERs.

Top 15 equity, balanced and monthly income funds by assets

Investors Dividend$13.60 0.022.71%9.14%7.21%
RBC Balanced$8.81
RBC Monthly Income$8.71 0.041.15n/a7.72
RBC Cdn. Dividend$8.66 0.051.7213.6210.68
CIBC Monthly Income$6.88 0.021.43n/a7.72
Mackenzie Cundill Value$6.61 0.102.4610.076.21
CI Cdn. Investment$6.56 0.062.2812.448.98
Trimark Select Growth$6.39 0.162.358.556.21
BMO Monthly Income$5.91 0.021.51n/a7.72
BMO Dividend$5.75 0.061.7314.5610.68
Templeton Growth$5.15 0.052.345.516.21
CI Harbour Growth
& Income$5.11 0.022.34n/a7.21
RBC Cdn Equity$4.77 0.071.9910.618.98
CI Harbour$4.72 0.022.34n/a8.98
TD Monthly Income$4.49 0.021.42n/a7.72

Top five equity, balanced and monthly income funds, by 10-year returns

Front Street Special
Opportunities Cdn.$163.17 0.622.59%+20.82%5.01%
Front Street
Small Cap Cdn.$241.02 0.332.67+18.3410.79
Talvest Global
Health Care$1,120.00 0.053.14+17.428.23
Chou RRSP$354.13 0.081.74+17.0213.2
Dominion Equity
Resource$37.26 0.812.5515.3210.82

Bottom five equity, balanced and monthly income funds, by 10-year returns

Fund ($million)TERMERreturnreturn
AGF Managed Futures$17.98 1.864.11%- 19.53%5.06%
Mavrix Growth$10.17 1.033.18- 7.418.92
Large Cap Growth$236.90 0.252.72- 4.314.32
Investors Japanese
Equity$344.00 0.192.73- 2.942.37
AIM American
Growth$27.98 0.083.13- 2.264.32


© 2007 The Globe and Mail. All rights reserved.

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