By Dan Hallett on October 3, 2011
The mutual fund industry seems to be under the microscope on a regular basis. That’s partly a function of its size. But, to be fair, it’s also because the industry has earned criticism for its commission structures, high fees and proliferation of gimmicky products. The issue of fees is the subject of perpetual debate. A recent letter by FAIR Canada has pushed the hot-button yet again.
A FAIR request
Finance Minister Jim Flaherty has asked the Senate National Finance Committee to examine why prices of many retail goods continue to be higher than in the U.S. while the Canadian dollar has been at (or near) par with the U.S. dollar for a year or more. Just over a week ago, FAIR Canada called on Flaherty to add mutual fund management expense ratios to that list of retail goods.
I have a great deal of respect for FAIR. Given that investor advocacy isn’t a high-paying job – it pays nothing, sometimes less – FAIR is a much-needed organization. But I think their request and fee comparison miss the mark.
Good vs. service
While a mutual fund is a financial product, it is a bundle of ‘services’ – i.e. money management, financial advice in many cases and financial administration. That is why mutual fund fees and expenses were previously GST-taxable. Many services, including money management, are regulated and provided to a residents of one or more specific jurisdictions. Mutual funds can’t be ‘shipped’ to another country and sold to its residents.
(Note: The Securities and Exchange Commission prohibits the sale of Canadian-domiciled mutual funds to U.S. residents. This is called a closed mutual fund market. Similarly, Canada is also a closed market. In Europe, it’s more common for funds domiciled in one country to be sold to residents of a neighbouring country.)
So as much as I’d like to see lower fees in Canada, I don’t understand the reasoning behind tossing mutual funds in a basket with running shoes, computers, books and greeting cards. Otherwise, we might as well add legal services, will kits and insurance policies to the mix.
To bolster its case, FAIR cited Morningstar’s global survey of fund fees and added its own comparison for good measure. This past March, Morningstar’s Chicago headquarters published the 2011 edition of its Global Investor Experience report. Fees and expenses were just one of the handful of factors on which Morningstar graded 22 countries surveyed in its report. But Canada’s failing grade on fees drew most of the attention. However, Morningstar’s fund fee comparison appears to suffer from weaknesses that plagued some others before it.
Morningstar compared fees via a survey format using the firm’s global mutual fund database. The nature of the survey questions and the vague descriptions in the text point to a superficial comparison. Here are just a few of the many issues that seemingly muddy its global fee comparison.
- Fund of fund fees are all-inclusive in Canada; not the case in many other countries.
- Trading costs incurred by the fund are excluded from published expense ratios. This is biased against Canada and the U.S. if our admittedly non-scientific survey is any indication. (See this article for one example.)
- The range of fees or the proliferation of low-fee product is not addressed.
- The content of what’s included in “equity” and “fixed income” categories is unlikely to be equal across 22 countries.
- There appears to be no attempt to compare the proportion of advice-seekers vs. do-it-yourselfers.
Further skewing this issue is FAIR’s own comparison of a Fidelity U.S. stock fund (sold in the U.S.) with a Canadian stock fund (sold in Canada). I would instead compare virtually identical funds but let’s go with FAIR’s chosen comparison for a moment.
The Fidelity Blue Chip Growth Fund‘s 0.92% expense ratio includes no trailing fee commissions. Meanwhile, their choice of Fidelity Canadian Large Cap‘s 2.28% MER includes 1% annually for advisors. When you control for trailing commissions, most of the difference disappears (1.28% vs. 0.92%). Pull out Canada’s GST/HST and the difference narrows further to an estimated 0.15% per year.
Fifteen basis points isn’t likely to inspire much action by Minister Flaherty. But stating that Canadian fees are nearly 150% higher than U.S. fees – as FAIR implies in its comparison – is more eye-catching. I estimate the true difference, when controlling for fund type and taxes at closer to 40-50 basis points annually.
What FAIR really seems to want is to unglue advisor compensation from product pricing. They clearly want more transparency for the investing public – a cause I personally support. But their focus on superficial cross-border price differences misses the mark. They’re barking up the wrong tree.
Low-fee advocates should vote with their wallets
As I’ve pointed out before, Canadian investors have easy access to a handful of low-fee mutual fund families in Canada. They also have direct access, via the Toronto Stock Exchange, to a growing number of exchange-traded funds. Perhaps more interesting is Canadian investors’ equally easy access to ETFs and actively managed closed end funds trading in the U.S.
What we don’t have – and the U.S. does – is every fund available in no load and load form. But if Canadians truly want lower fees, then they should stop investing in funds with higher fees. If more Canadians voted with their wallets, we’d see more price competition in Canada. For example, if a Canadian DIY investor wanted exposure to domestic stocks, why not invest in something like Mawer Canadian Equity (1.24% MER) instead of Fidelity Canadian Large Cap with its higher fee?
Let Google help you. Simply typing in the phrase “low fee mutual funds Canada” results in lots of good suggestions. The founder of one of the higher profile low-fee firms in Canada – Tom Bradley of Steadyhand Investments – writes bi-weekly for Canada’s largest paper. He’s easy to find – and he’s one of the nicest guys in the business.
The industry has its share of blemishes – from market timing scandals to conflicted trades and poor governance. But that doesn’t mean we should blame the industry or regulators because Canadians want advice (which costs more) and choose not to put their money into cheaper investments.