Study finds Canada has the highest mutual fund fees in the world

By Glorianne Stromberg | October 2006

Academic studies do
not usually grab the Canadian financial services industry by the short hairs. But a recent study, Mutual Funds Fees Around the World, by three professors — Ajay Khorana of the Georgia Institute of Technology, Henri Servaes of the London Business School and Peter Tufano of the Harvard Business School — certainly has.

And it is no wonder. The study finds that, after adjusting for fund type, fund size, complex size and other variables, Canada has the highest fees by far. The authors say the all-in cost of holding a mutual fund — including the sales charges some funds levy when money is withdrawn after five years — would amount to 4.68% of an investor’s assets each year. This, they say, compares with 1.68% a year in the U.S., where deferred sales charges are less common, and with an average of 1.84% in 14 other countries.

The study is not the first to point out the high fees that characterize the Canadian mutual fund industry. Two recent ones are Expense Ratios of North American Mutual Funds, by Karen Ruckman of the John Molson School of Business at Concordia University; and What Canadians Pay for Fund Management, by Mark Warywoda of Morningstar Canada.

TheInvestment Funds Institute of Canada has stated that it will “make a full public response” by the end of September. In the meantime, the reaction by some in the industry is akin to the refrain “say it ain’t so” as they struggle to find fault with the premises on which the Khorana et al study is based.

The incontrovertible fact is that costs matter. And Canadians who invest in the high-cost mutual funds offered by the Canadian financial services industry are unknowingly giving up an exorbitant amount of the long-term capital they would otherwise be accumulating while needlessly exposing themselves (based on their actual return) to the market risk of loss of capital. This is unconscionable.

It is a systemic and societal problem that legislators need to address without delay if Canada is to avoid the huge social costs, high taxation and lack of productivity that will flow from the need to care for the large segment of its population that will not have sufficient savings to provide for their own financial well-being.

It is beyond belief that the financial services industry has not taken steps to address the problem of ever-increasing costs and that it stonewalls regulatory and self-regulatory initiatives to do so.

The arguments that competitive market forces are sufficient to regulate the matter and that the marketplace is efficient simply do not hold water in the face of the investing public’s lack of knowledge and awareness of what is on offer by the financial services industry. It is a classic case of informational asymmetry, in which the sellers know more than the buyers.

In addition, there is a lack of equal bargaining power. The situation is aggravated by an industry that preys upon its customers by encouraging them to rely on them for strategies to financial well-being. Charging what the market will bear in these circumstances is akin to shooting fish in a barrel.

What will it take to end this shameful situation? One solution would be through the courts finding that these high-cost products are not suitable investments. Another would be for Canadians to realize that these high-cost investments are not a prudent way to accumulate savings and to stop investing in them. Another would be for legislators to act.

Yet another would be for legislators, regulators and the industry to remedy the factors identified in the Khorana study as contributing to the high costs — the quality of the legal system in general and investor protection in the fund industry in particular. For example, the study finds that fees are lower in countries in which custodians are required to be independent (a requirement that does not exist in Canada), foreign competition is allowed and there is a less-concentrated banking sector or one in which banks are not allowed to enter the securities business. Greater investor protection is seen as relating to lower fees.

Meanwhile, those who ignore the study’s findings may find themselves in the shoes of the farmer who killed the goose that laid his golden eggs. IE