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Canadian MERs - An Outrage
Canadian investors pay the highest mutual fund management fees of any country in the developed world. Not a little bit more - a LOT more. Find out why, the real cost to Canadian investors and what they can do about it
- The IFIC responds.
- Updated Report (Jun 2007)
- Canadian Discount Brokers
Mutual Fund Management Fees Take Canadian Investors on an Expensive Ride
I have been investing in U.S. mutual funds since the early 1980's and have extensive experience with U.S. no-load mutual fund companies such as Vanguard, T.Rowe Price, Scudder, American Century & Janus, among others.
I recently had the opportunity to investigate Canadian mutual funds and what I saw, absolutely shocked me. Canadians pay more for their mutual funds than any other developed country. Not a little bit more - a LOT more! More than any of the other 18 industrialized nations that were the focus of a joint Harvard and London Business School study, published last year (Source: Mutual Fund Fees Around the World - Feb. 2006 Draft).
The study found that Canadians pay a TER of 2.68%. Compare this to U.S. investors, who pay 1.42%. The next closest country was Luxembourg, at 1.75%, which is still over 90 basis points less than the Canadian mean.
A 0.93% to 1.26% difference in management fees may not sound like a lot, but it's nearly 1.9 times more than what U.S. investors pay and the dollar value, over the lifetime of a typical RRSP, will add up - both in terms of direct fees and loss of investment return. It's an albatross around the neck of Canadian mutual fund investors.
To learn why Canadian investors pay the highest MERs of any country, see how much money this can cost them on a typical investment and what they should do to stop it ... read on.
Survey Says: Canadians "Happy" to Pay More
The IFIC held their 20th Annual Conference in Toronto in September of 2006. There, they released the results of a telephone survey done by Pollara Inc., in which nearly 2000 Canadian fund owners responded to various questions about their mutual fund investments.
A Microsoft PowerPoint presentation of the survey results (which can be downloaded here) was summarized by the IFIC as follows: "Mutual fund investors in Canada are confident in mutual funds' ability to meet their household's financial goals and comfortable with their understanding of their investment" (source).
84% of Canadians are comfortable paying the highest mutual fund fees in the world!
2006 IFIC Poll
With regard to mutual fund fees, 84% were "comfortable" with the amount they paid in fees and 82% were "comfortable" with their understanding of where the fees went. It should also be noted that the majority of Canadian fund owners (85%), purchased their mutual funds through a professional advisor.
Not everyone, including me, is comfortable AT ALL with the management fees charged by Canadian mutual funds. Even industry insiders are complaining about the high MERs paid by Canadian investors. Known as "mohican', this British Columbia financial planner says that of the 3,783 mutual funds in Canada, 424 (11.2%) have an MER greater than 3.0% and that 1470 (38.9%) have an MER greater than 2.5%. Outrageous!
Why are Canadian Mutual Fund MERs so High?
The Globe and Mail article got it right: Canadian "Mutual Funds aren't bought, they're sold."
Hidden in the MER for most Canadian Mutual Funds, are "trailer fees" (which cover the expenses and commission for the "professional advisor" that 85% of Canadians utilize to buy their funds). These trailer fees are "fairly specific to Canada, which helps to explain why fees on Canadian mutual funds are among the highest in the industrialized world."
In the United States, I am used to having the ability to buy mutual funds directly from large mutual fund companies. In Canada, many of the leading mutual fund companies (by asset base) are associated with major banks (RBC, TD, BMO, CIBC and Scotia). (Source IFIC) The industry as a whole, employs over 90,000 people (2001 data from www.fin.gc.ca). That's a lot of people and now, in 2007, it is probably a lot more.
Because it is tax season, there have been a lot of television and print ads (*cough*, which raises management fees) trying to catch RRSP investments. A recent RBC print ad states, "There's [a financial advisor] in every branch" (how convenient and EXPENSIVE). In the fine print, they explain who pays for them - "Royal Mutual Funds, Inc." A quick look at the RBC website shows 1,104 RBC branches in Canada and 1500 financial advisors (437 investment retirement planners and 1,063 financial planners). RBC mutual fund investors are pay for these advisors with their hard-earned savings.
An mutual fund watchdog group in Canada, CanadianFundWatch.com cited a Toronto Star article in their January 2007 Newsletter, which relayed a quote by Karen Ruckman, professor of business at Simon Fraser University. She said:
They [Canadian Mutual Funds] can do this [charge more] partially because Canadian consumers know nothing about how low MER's should be and partially because they don't have to disclose what their trailer fees - the amount of fees paid to the broker – are. This is notoriously higher in Canada than in the U.S. but no one knows by how much because they don't have to disclose them.
There are other reasons for why Canadians pay the highest management fee in the industrialized world. Economy of scale is one (but that really doesn't wash, because Luxembourg has a smaller investor base than Canada and yet, manages much lower management fees). That mutual fund regulations are handled on the Provincial level, and not the National level, is another argument. This undoubtedly adds to the cost of operations, but only marginally so. The lion's share are the trailer fees.
Until the Canadian Mutual Fund industry reports the management fee break-outs, all anyone can do is conjecture about where the management fees are going. In the end, it's academic. The real problem is that Canadians are paying substantially more in management fees than anyone else in the world, regardless of how the money is spent. It's completely out-of-line with the rest of the world and needs to change. The end result is that mutual fund management costs are ripping Canadian investors off. They're taking money from Canadian investors and lining the pockets of the mutual fund management team, the very team that claims to be looking out for the investor's interest!
What do the Best-Paid Managers Provide Canadian Investors?
Only 20-30% of Canadian fund managers beat the S&P/TSX benchmark against which they're measured.
One of the arguments for higher management fees is the fact that you often pay for what you get, namely the erudite stock picking of the fund portfolio managers. The idea is that you should look at a fund's overall return and not focus solely on expenses. (Some of the best funds, with the highest returns, have high management expenses because they employ the best managers).
It's true, you should not invest in a fund simply because it has a lower management fee. In fact, in that same January 2007 Report, CanadianFundWatch listed 8 mutual funds with high MERs that have justified their fees with very solid pre-tax returns (page 6).
However, just how many great managers are there? Standard & Poor's SPIVA scorecard continually reports that most Canadian equity mutual fund managers fail to beat their respective benchmarks (indices) against which they are measured. For the Q01, Q02 & Q03 in 2006, only 30.2%, 19.8% and 26.7% of actively managed Canadian equity funds, respectively, managed to beat the S&P/TSX Composite Index. (SPIVA link).
Only 20-30% of actively managed funds do better than the index? With such horrible results, the argument for high management fees buying great managers, is very weak. You've got an 70-80% chance of paying high fees and not even beating an index. Yuck.
Take heart if you're invested in a Canadian small-cap fund, as about half manage to beat their index (the S&P/TSX SmallCap Index).
These percentages are not a one-off, they hold consistently for longer periods (3 to 5-year range) as well.
What's the Cost to Canadian Investors?
Based on SPIVA data, there is a strong argument for investing in index funds, which by design, have much lower management fees. In fact, a Canadian investor would have a 75% chance of outperforming all actively managed Canadian mutual funds that aim to beat the S&P/TSX Composite Index, if they just invested in a fund that tracked that index. Those are odds I like. (Index funds aim to track the performance of their respective index, eliminating the need for an active, stock-picking management team).
A Canadian investor can lose nearly 40% of their profit, over 20 year period, because of high management fees.
The problem I found, however is that the MER for many Canadian index funds, aren't substantially lower than many of the actively managed funds. Looking at the CIBC family of index funds, the lowest MER for any of their index funds was 1.0% and the highest was 2.0% (Source: 2006 Simplified Prospectus).
Say a Canadian investor wanted to invest in a European Index Fund, which tracks the MSCI Europe Index. The reported MER for that CIBC Fund is 1.2%. Compare that against the same index fund at Vanguard, in the United States, whose MER is 0.27%. They both track the same index and will yield a nearly identical return, for a given dollar amount invested.
Using the Mutual Fund Fee Impact Calculator at the Canadian Investor Education Fund website, one can see calculate the impact of higher management fees has on investor yield. Assume both invest $20k and let it grow for 20 years. The U.S. investor will have a final investment value of $105,646.49, after paying $2,784.14 toward management fees. In contrast, the Canadian investor will have paid nearly four times the amount in management fees ($11,108.26) and end up with a much lower investment value, as a result ($88,276.95). The true cost of the fees, to the Canadian investor, will be $17,369.54, nearly 20% of their final investment value!! It doesn't take a rocket scientist to realize whose got the way better deal (and why I am so SHOCKED to see how high management fees were for Canadian mutual funds).
One might argue that comparing Vanguard (which is widely-recognized as having among the lowest management fees in the United States) and CIBC is not fair. OKAY ... just use the respective mean TER values of the aforementioned report, namely 2.68% for Canada versus 1.42% in the United States. The results are still as enlightening. The U.S. investor walks away with $115,516.44 (after $15,589.01 in fees), while the Canadian investor is taken to the cleaners, walking away with only $87,354.77 (after shelling out $24,832.41 in fees). Same investment return. The only difference is the difference in management fees.
This data should make more than a few a few Canadian investors sit up and take notice.
To add insult to injury, I don't think the "investment advisor" I met with at the local CIBC bank (a fellow in his early thirties, who used the word "awesome", probably 25 times over the course of an hour) adds much VALUE to any investment. In fact, for this U.S.-experienced investor, he seems more a hindrance to me (as I am used to investing directly with mutual fund companies in the United States, either via mailed checks or electronic fund transfers). To have to make an appointment and have a face-to-face meeting to open an account, exchange shares or withdraw funds seems incredibly archaic to me. (Especially when I had to wait for 15 minutes past my original appointment time).
What Can Canadian Investors Do?
At present, there seems to be very little hope for Canadian mutual fund industry reform. Consider: the size of the work force that is already dedicated to providing "investment advice"; the difficulty to obtaining agreement at a Provincial and Territorial level; the fact that the mutual fund industry is largely self-regulating (how silly is that?); and that banks are among the largest mutual fund brokers (we all know how banks like to crow-bar money from their customers).
Nope. I can't see any real change on the horizon, this despite how obviously out-of-step the Canadian mutual fund industry is with the rest of the world. (They've already got their best spin doctors working the case, but they're spinning in vain).
There is hope. First, a Canadian investor needs to realize that they stand a better chance of reaping a higher reward if they ditch their actively managed mutual fund and follow an index. If they can make that leap, then the next step is to move away the mutual fund company altogether. Canada ... vote for mutual fund reform with your feet. Buy Exchange Traded Funds (ETFs).
The Canadian investor can open a self-directed RRSP account with a discount broker and purchase ETFs as you would a stock. The MERs are very low, compared to Canadian mutual funds. You do have to pay a broker fee when you buy or sell, which is why you should use a discount broker and take a buy-and-hold approach.
I'll be putting my money where my mouth is, because this is the approach I'm recommending and using for our family's Canadian investments. While I have a couple of ETF's in the United States, I've been quite happy with the low MERs at fund companies like Vanguard and T. Rowe Price and haven't the need to purchase many. Not so here in Canada.
Next: ETFs, Discount Brokers and Moving RRSP money. (If there is enough interest in this article, my plan is to offer a step-by-step guide for Canadian investors who want to stop paying high MERs to mutual fund companies - largely banks - and keep more of their own, hard-earned money, for themselves. I'm following my own advice and voting with my feet!
It's not surprising that the IFIC would find the report "Mutual Fund Fees Around the World" distressing. After all, the world-wide comparison blatantly revealed that Canadian mutual fund investors were paying the highest mutual fund fees.
Updated Report - "Mutual Fund Fees Around the World" (July 2007)
Their only response was to debunk the study and that's what they tried to do (paraphrasing): "You excluded low-fee funds ... loads are not representative ... holding period is longer in Canada ... Canadians prefer an advisor ... the comparison is dated ... blah ... blah ... blah."
You can read the sour grapes response here.
The author's come-back amusing (paraphrasing): "Urm, we can understand why you find the results troubling ... but our study wasn't a U.S.-Canadian comparison ... a country on which you seem to focus ... we carefully did our work and regardless of differing approaches, the results are the same ... costs were higher in Canada than (list of all the other countries). We have no vested interest in the outcome of the report and make no value judgment about fees in Canada ... have a nice day."
The authors then go on to explain, point-by-point, how the IFIC complaints are unwarranted. Other countries have similar situations, they're handled on an egalitarian basis and the results are consistent. You can read the reply here.
The bottom line is that Canadian mutual fund investors are paying the highest mutual fund fees in the world. To avoid these outrageous fees and retain the benefit of diversification, Canadians should avoid mutual funds and invest their RRSP money in Exchange Traded Funds. Additional savings can be realized by purchasing ETFs through a discount broker, such as Questrade or TradeFreedom.