The Canadian mutual fund industry has earned a grade of B in a new report from Chicago-based Morningstar Inc. evaluating the industry from the perspective of the investor, but received a failing grade for fund fees and expenses.

The report, called Global Fund Investor Experience, evaluates the mutual fund industries of 16 countries based on surveys of Morningstar analysts in each respective country. It assigns each country a letter grade based on evaluations in six areas: investor protection, transparency in prospectus and shareholder reports, transparency in sales practices and media, fees and expenses, taxation, and distribution/choice.

In the category of fund fees and expenses, Canada came dead last out of the 16 countries, receiving a grade of F.

The study found that Canadian investors typically pay front-end loads between 4% and 5%, higher than the average international range of 2% to 3.99%. This is primarily because investors are unaware that this fee is negotiable, according to Morningstar.

But this does not represent the true investor experience in Canada, according to the Investment Funds Institute of Canada. A front-end commission of 5% is very rare, especially in the current environment, said Dennis Yanchus, manager of statistics and research at IFIC.

“There’s a lot of competition in the market, a lot of advisors are either charging zero, or 1% or 2% commission front-end,” said Yanchus. “That’s the investor experience.”

The report also finds that Canadians pay higher than average expense ratios. The typical MERs for fixed-income, money market, and equity funds around the world range from 0.76% to 1%, 0.40% to 0.89%, and 1.50% to 1.99%. While MERs for money market funds in Canada fall into the same average range, expense ratios for fixed income funds are typically 1.25% to 1.49%, and MERs for equity funds range from 2% to 2.5% Morningstar finds.

“Canadian investors are comfortable with the fees because they don’t know how low these fees should actually be,” the study says. It adds that financial advisors tend to direct client assets to funds that pay better trailers, which results in a flow of assets into higher-fee funds.

“We encourage fund companies in Canada…to lower their fees and expenses for the benefit of the investors,” the report says.

IFIC argues that the study fails to provide an unbiased cross-country comparison of fees, since the fees included in MERs vary between countries.

“In some countries, ongoing service fees, like a trailer fee, aren’t included in the MER,” said Yanchus. “If you’re going to do this kind of a study, you better make sure that you understand what’s included in the MER across countries.”

If such differences were accounted for, the fees in Canada would in fact be much more in line with those of other countries, Yanchus said. “The differentials between Canada and the U.S., or Canada and other countries, would be very small,” he said.

Canada earns top spot for investor protection, transparency

Canada took the top spot of all the countries in a number of other categories, including investor protection and transparency in prospectus and shareholder reports.

In particular, Morningstar commended the simplicity and accessibility of the simplified prospectus in Canada, and the availability of detailed information for fund investors. The study praises Canadian prospectuses for clearly identifying the fees and expenses associated with fund investments, and for providing transparency on items that funds in many other countries do not. Examples include the history of expense ratios, securities trading costs, the names of portfolio managers and semi-annual portfolio holdings disclosure.

Canada also earned a grade of A for transparency in sales practices and media. Morningstar noted that Canada has regulations clearly defining appropriate and inappropriate behaviour. But the report notes that flaws exist in this area, including the common practice of using sales contests to motivate sales of funds.

“This implies that the fund industry’s sales force can lack independence in certain instances and is more likely to promote funds for self-interest rather than the best interest of the investor,” the report says.

Canada was also awarded high marks in the distribution and choice category, coming in second place behind Japan.

“Investors in Canada have a wide range of distribution options,” Morningstar notes.

In the taxation category, Canada lagged many other countries, earning a grade of C. The study points out that there is no difference in the taxation of short-term capital gains versus long-term capital gains. The tax system could be improved by implementing a more favourable tax rate on long-term capital gains to promote longer-term investing, according to Morningstar.

@page_break@IFIC stresses that since research for the study was based on surveys with Morningstar analysts, its findings do not reflect the experience of investors.

“This isn’t based on actual trading data or the actual investor experience,” said Yanchus. “Those statements are really just the opinions of Morningstar analysts.”

IE