Without a doubt, cost is one of the major hot buttons facing the mutual fund industry today. This is understandable because high fees can significantly reduce returns and the long run impact can be quite substantial. According to various studies, fees can eat up a surprising 35% of the total returns over an investor’s lifetime. This assumes that positive returns have been realized. The studies also point out that Canadian mutual fund fees are arguably the highest in the developed world. Moreover, the management expense ratio (MER) only describes part of the overall cost; additional costs are sometimes confusing or discreet. Countless news articles have been written to highlight these statistics and the general public is more sensitive than ever to mutual fund fees.
Fees are necessary for firms to be able to provide a good service, however it is important for clients to understand all the costs to which they may be exposed. Unfortunately, there is often a lack of understanding of the true cost, which is one of the most common problems cited by affluent clients and the second most common reason for switching financial institutions.
MERs are published in newspapers and over the internet. For instance Investor Economics disclosed that the asset weighted MER for long term segregated funds wrapping mutual funds was 3.13% and long term mutual funds was 2.28% as at December 2006. Cost disclosure in the fund industry has traditionally been very good. There are however, some additional costs in managing a mutual fund that are not included in the MER such as trading, administrative and distribution costs.
With respect to trading costs, it costs something to buy and sell the securities within a fund. Fund companies pay commissions on all trading in multiple markets and these are passed onto clients. Commissions are capitalized, not expensed, and as such are excluded from the MER. Additionally, a fund company may need to “pyramid trade” a very large position so as not to move the market. You should pay special attention to the turnover ratio of a fund. The higher the turnover ratio, the higher trading costs will be in addition to the MER. Trading can add between 0.15% and 3.0% to the cost of fund depending on the turnover ratio.
Administrative costs may include the costs of customer service, mailing and record keeping. Depending on the fund’s fee structure some fund distribution costs may not be included in some MERs so further research there may be required.
Unlike mutual funds, with a Separately Managed Accounts (SMA) program, clients pay an all-inclusive fee which can help meet most affluent clients’ expectations. Other benefits include:
- Transparency: fees are visible and depend on the size of the assets; this makes it clear that client’s interests are in sync as you both benefit when assets grow.
- Accountability: clients are in a better position to compare fees on their assets with services received in return. This eliminates any apparent conflict of interest.
- Enhanced customer relationships: clients will see the advisor as a “true” professional and have the opportunity to ask strategic questions rather than have transaction based conversations.
It’s not that difficult to find a fund’s Trading Expense Ratio (TER); a mutual fund’s trading expenses are an additional cost to the client on top of management expenses. These costs, expressed as a percentage or ratio, can be found on the System for Electronic Document Analysis and Retrieval (SEDAR). The SEDAR system facilitates the dissemination of public disclosure documents that are required to be filed by reporting issuers under Canadian securities legislation.
- go to Sedar.com
- choose language
- choose “Search Database”
- choose “Investment Fund Documents”
- type in the name of the fund or fund family
- under “Document Type” choose “Management Report of Fund Performance”
- ensure the “Date of Filing” range spans the month of June
- click on the “Search” button
- choose the appropriate document
- type in the appropriate Code Verification password
- click on the “Accept” button
Once the information downloads, look for the “Ratios & Supplemental Data” table for the appropriate fund class. This table includes the “Trading Expense Ratio” which is over and above the Management Expanse Ratio (MER).