Investors doing a straight comparison of managing expense ratios (MER) and total expense ratios (TER) between Canadian and American mutual funds may be missing the bigger picture, according to a study released on Wednesday by the Toronto-based Investment Funds Institute of Canada (IFIC).
A straight comparison of a Canadian MER against an American TER suggests that Canadian mutual funds in advice channels are more expensive than their fee-based American counterparts. However, IFIC’s study shows that to have a true understanding of the cost of owning fee-based U.S. mutual funds, investors must include the external advisor fee.
When that external fee is taken into account the cost of ownership (CoO) of mutual funds are virtually the same throughout on both sides of the border and the world, says Avi Nachmany, director of research, executive vice president, Strategic Insight, give or take about 10% of the final cost due to different regulatory and legal costs. As well, in some cases, the costs of unbundled, fee-based programs can be even higher.
For example, the study shows that for an advice-channel Canadian mutual fund with a fee of 2.21%, the pre-tax CoO (mostly consisting of the MER) makes up 2.02% of that figure with taxes forming the remaining 0.19%. In the U.S., the study found that a fee-based mutual fund charges varies between 1.7%, 2% and 2.4%. Of that fee, 0.7% to 0.9% is the TER, while an external fee-for-service charge can be anywhere from 1% to 1.5% depending on the advisor.
The CoO is calculated in the study using the following formula:
Acquisition costs (front-end load sales commission, other transactional and account opening fees) + ongoing costs (embedded fees, such as fund management, trailers, operating expenses and taxes, and unbundled fees meaning fee-for-service and administration costs) + disposition costs (redemption fees and other transaction costs) = CoO
It is important to note that, according to the study, mutual fund acquisition and disposition costs are practically non-existent now.
The study consists of three parts: an overview of the Canadian mutual fund fees, conducted by Toronto-based Investor Economics; a U.S. version completed by New York-based Strategic Insight; and a comparison of the difference in fees in the two countries.
Its purpose, says Joanne De Laurentiis, president and CEO, IFIC, is to act as a foundation for future industry discussions about mutual fund fees. “What we hope to do with this,” says De Laurentiis, “is whatever future discussions we’re going to have around fee issues, at least have them based on real, solid, empirical data.”
Part of that discussion may well be around the issue of fee disclosure. A recent discussion paper by the Canadian Securities Administrators raises possible conflict of interest issues caused by embedded fees commonly found in Canadian mutual funds. However, the paper does not go so far, in De Laurentiis’ view, to suggest that the Canadian financial services industry should follow the example of the American unbundled, or fee-for-service, strategy.
“To my mind when I read that paper, it does not exclude the approach that we’ve been on so far, which is a disclosure regime,” she says, “but you just have to make that disclosure regime more precise.”