are paying the highest mutual fund fees in the world, concludes a report that examined 46,799 mutual funds in 18 countries, accounting for 86% of the global fund industry.
Some in the domestic industry take issue with the report, and others say many clients may not be aware of the expense because they pay little attention to their fees.
The report, entitled Mutual Fund Fees Around the World, states that “Canada is the single highest fee country by far.”
Published in February in a draft version that is being circulated for comment, the 52-page report was written by academics Ajay Khorana of the Georgia Institute of Technology, Henri Servaes of the London Business School and Peter Tufano of the Harvard Business School.
“While the fund product is similar around the world, the prices charged by funds are very different from place to place,” the authors write. “Even neighbours, such as the U.S. and Canada, can have remarkably different fees.”
Moreover, they found “little evidence of economies of scale manifested in management fees, but larger effects in total expense ratios and total shareholder costs.”
Rather than use the standard terminology, such as management expense ratio, the authors created their own: TER is defined as all annual expenses levied by the fund on investors, but excludes some types of distribution fees such as back-end or front-end loads, as well as fees that may be charged by wrap accounts; TSC includes the TER plus an annualized form of loads or sales commissions.
Based on the authors’ sample, the average TER for a Canadian equity fund, for instance, is 2.87% and the TSC is 4.93%. The numbers put Canada at the top of the list.
In contrast, the average U.S. equity fund TER is 1.71% and the TSC is 1.99%. The Netherlands has the lowest fees, boasting and an average TER of 0.79% and an average TSC of 1.16%.
When only fund-management fees are taken into consideration, Canada’s equity funds are the most expensive in the world, at 2.11%. The U.S. and Denmark are tied for the lowest MERs in the equity category, at 0.79%.
The full report is available on a Web site: http://papers.-ssrn.com/sol3/papers.cfm?abstract_id=901023.
Co-author Tufano says the academic peer-review process is long “and we cannot at this point guess when our paper will be ultimately published in a journal.
“However, it is common to circulate working papers in advance of the ultimate publication. The final version could differ from the current version, depending on the comments we receive throughout the editorial process,” he adds.
Reaction to the report within the Canadian fund industry, and by outside observers, is split between skepticism and agreement. Even those who think fees here are high don’t believe they are anywhere near as high as the academics claim.
David O’Leary, manager of fund analysis at Toronto-based Morn-ingstar Canada, supports the report’s findings and maintains that fees are “substantially” lower south of the border. One key reason is structural differences. “The Canadian fund industry is more concentrated than in the U.S.,” he says. “The more concentrated, the less competitive fund companies have to be.”
U.S. funds also benefit from economies of scale, he says. For instance, the US$63.8-billion Fidelity Contrafund, one of the largest funds in the U.S., charges an MER of 0.91%. Canada’s biggest fund, the $11.8-billion Investors Dividend Fund, charges an MER of 2.75%.
There is also an extra “dynamic” at play in Canada, says O’Leary. Advisors receive a trailer fee for their services, which ranges from 0.5% to 1% for equity funds, and it comes out of the MER. “Advisors deserve to be paid, as they perform a useful service,” says O’Leary. “But the trailer is going to affect their search and they will try, where they can, to steer clients to a fund that pays better, as long as the fund meets their clients’ needs.”
Some question the report’s methodology. Brenda Vince, president of Toronto-based RBC Asset Management Inc. , says the authors do not fully appreciate the variety of sales channels through which mutual funds are sold.
“Are the funds sold directly, such that the fee is only for fund management plus expenses? Or are the funds sold through an advisory model, which means advisory compensation that is built into the fund or charged separately?
@page_break@“Are they comparing apples to apples? To make simplistic assumptions is a bad thing, too,” says Vince, who argues that Canadian fees are not so different from other countries so long as the comparisons are done fairly.
Another skeptic is Dan Hallett, head of Windsor, Ont.-based Dan Hallett & Associates Inc. Even though he believes fees are high in Canada, he questions the authors’ claims.
In an e-mail to the authors, Hallett pointed out discrepancies in their calculations. The authors believe there is a huge gap between the Canadian fees for Fidelity Japan Fund and the same one sold in the U.S. The former’s fee is 2.69%, including a 100-basis-point trailer. The U.S. version’s fee is 1.02%.
However, Hallett noted, no mention is made of the so-called “12b-1 fees” that advisors collect from clients in the U.S. In his view, that boosts the U.S. fee to a total of 2.26%. In effect, the differential is not 167 bps but 43 bps.
“In the U.S., you can buy stripped-down versions of a fund. In that context, the comparison holds. But for those seeking advice, it doesn’t,” says Hallett. “In the study’s comparison, one version includes compensation; the other does not.” He adds that the authors have admitted they did not have information regarding payment by investors to distributors in the U.S.
“Maybe we are more expensive, but not by a factor of two or more,” Hallett says, scoffing at the authors’ claim of a 298-bps gap between their overall sample of Canadian funds vs those in the U.S.
The underlying problem could be that compensation’s complex nature makes it hard for outsiders to make fair comparisons, says Jag Alexeyev, managing director of Strategic Insight, a New York-based firm that monitors the U.S., European and Asian fund industries.
“Depending on the country, fees may be bundled together and there may be other external fees that are not included, such as sales or exit fees that compensate advisors,” says Alexeyev. “What looks high in one market may not be high, if you carefully exclude those other charges for distribution and advice that do not represent fees charged for money management.”
Even though Alexeyev is not familiar with the study, he says, “In the past, much of the fee analysis has been off the mark because many people haven’t separated those components out.”
Although the debate continues, industry participants concede that investors simply don’t understand the fees they are paying.
“There is a lot of misinformation and confusion,” admits RBC’s Vince. “That results from the fact we have a pricing model that combines manager and dealer compensation in a way that is hard for people to parse out.”
In spite of her firm’s extensive fee and compensation disclosure, Vince admits most investors do not spend a lot of time reading the materials: “We assume people understand what they are reading, but we have to say they don’t.”
It’s a brutal reality that analyst Gordon Pape also notices. “In-vestors pay little attention to MERs and only look at the net return,” says Pape, publisher of Toronto-based Internet Wealth Builder. “Unless that return is below expectations, they may not shift their focus to the MER to see why the return was low. They are somewhat blinded in that way. But savvy investors will look at the MER and the performance history.” IE