The cost of owning the average mutual fund

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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Norbert Schlenker
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Post by Norbert Schlenker »

DanH wrote:1. The formula they use to compute Total Shareholder Costs (TSC) is overstated because it includes an annualized front end load + an annualized back end load. Hate DSC all you like but no investor I know of is capable of incurring a front and back end load on the same purchase.
The description in the paper of their TSC calculation is ambiguous. I don't see how you can conclude they have double counted.
2. The comparison of Canadian fund fees to U.S. funds (and to other countries) is flawed because Canadian funds include compensation to distributors while U.S. funds often do not. The comparison they make in the paper (p 21) is between U.S. and Canadian versions of Fidelity Japan. They state the ER difference is 167 basis points. But it's actually about 55 basis points when controlling for things like payments to distributors (which the authors acknowledge they have no data on) and GST (i.e. to isolate investment and regulatory expenses only).
Whoa! Control for GST if you like because that is clearly outside the influence of Fido. But you can't just say, "Well, they pay 100bp for distribution in Canada vs. 0 in the US, so we'll just discount that difference." It's Fido's business decision to pay 100bp for distribution in Canada and not the US. You can't just wave it away, any more than you could wave away a business decision to buy all the portfolio managers Ferraris.
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Post by DanH »

Norbert Schlenker wrote:The description in the paper of their TSC calculation is ambiguous. I don't see how you can conclude they have double counted.
From Mutual Fund Fees Around the World, pp 12-13 of the printed version (14-15 of the pdf):
Our measure of total shareholder charges (TSC) includes the expense ratio plus annualized loads. Because loads are paid when entering and exiting the fund, it is necessary to divide these loads over the investor's holding period. We assume a five-year holding period in our analysis. This also allows us to compute the back-end load, because these loads often decline as the holding period increases. To do this, we study, for each fund, the schedule of loads and obtain the load paid by an investor with a five-year holding period. Thus, we define total shareholder cost (TSC) as:

Total Shareholder Cost = TER + initial load/5 + back-end load at five years/5

We have fewer observations on the TSC because these data are only available from Morningstar. Our five-year holding period estimate is admittedly ad hoc, as we do not have data on actual holding periods by fund. We also acknowledge that our information does not include any non-load charges levied by the distribution channel.
Norbert Schlenker wrote:Whoa! Control for GST if you like because that is clearly outside the influence of Fido. But you can't just say, "Well, they pay 100bp for distribution in Canada vs. 0 in the US, so we'll just discount that difference." It's Fido's business decision to pay 100bp for distribution in Canada and not the US. You can't just wave it away, any more than you could wave away a business decision to buy all the portfolio managers Ferraris.
So, it's okay to wave away fees that U.S. investors pay to distributors? Wouldn't that also qualify as a "shareholder cost"? Bundled or unbundled, a cost is a cost. Based on the illustration they provided (re: U.S. and Canada comparison), it doesn't appear that they used any of the lower fee classes like I, F, or other low fee classes.

As noted in my submission to the authors and somewhere upthread, this is a fine comparison for DIY (though they continue to have lots of low fee options in Canada). But for advice-seekers, this is a distorted comparison.

Are fees high in Canada? Yes. Are they higher than in the U.S.? Yes. Are they the highest in the developed world, by far? I don't think any of us has enough information to answer that question.
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Post by The Wealthy Boomer »

Here's what one fund manager just emailed me from his blackberry about the article and fees in Canada:

"Our total advisor compensation structure is excessive."
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Post by DanH »

The Wealthy Boomer wrote:Here's what one fund manager just emailed me from his blackberry about the article and fees in Canada:

"Our total advisor compensation structure is excessive."
Let's not take this thread off on a tangent. We're not debating whether or not advisors are paid too much. I think that horse has been beaten to death. And I don't know who the fund manager is but one could also make arguments that some portfolio manager compensation schemes are excessive. (In the extreme, I'm reminded of the ludicrous pay packages that some Janus fund managers were paid a few years ago.) But let's stay on topic, shall we?

The Fidelity Advisor Japan C sold to U.S. investors includes a 1% annual 12b-1 (trailer) fee in its 2.26% MER. That's pretty much on par with Canadian A-series funds though the MERs are still a bit higher here.
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Post by beaverlodge »

"Our total advisor compensation structure is excessive."
From his blackberry? Does it matter?
A successful manager? A failed manager? A flawed manager? A bitter manager? We will never know.

Maybe it is time that there is an in depth report on the incomes of the fund managers, how they are compensated, and how they have performed.

Maybe it is also time to take all advisors out of the structure and see what the results are.

Maybe it is time to take all advisors out of the structure that enter it from other areas of work and are suddenly experts in an area that can be harmful to consumers.

A likely outcome would be complete control of wealth management by the banks.

If you love your banks maybe it is time to turn it all over to them.

Love your bank. Hate your advisor.
The latter charges too much anyway. And the banks are fair to the consumer.
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Post by worklessplan »

Dan, thank you for taking the time to read the article and commenting.

Although your comment DIY investors have lots of low fee options in Canada is true for many of the large asset classes, I have not seen much low fee product (usually passive management) for commodities, emerging equity, foreign bonds, real estate etc. There is often only 1 supplier or sometimes no suppliers in Canada to choose from.

I wish we could buy some of the American product but USA mutual funds, apparently, are not allowed to be bought by Canadians.
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Post by AltaRed »

worklessplan wrote: I wish we could buy some of the American product but USA mutual funds, apparently, are not allowed to be bought by Canadians.
True, no access to US domiciled mutual funds, but there are many ETFs (US$ denominated) to choose from, e.g. Barclays, Vanguard. But you also have to watch the MERs/expense ratios on some of the sector offerings as they tend to creep up as well. I have been sifting through the many offerings to try an find a reasonable allocation amongst them...but no plan yet.
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Post by worklessplan »

When I last looked at some USA ETF's to compensate for the lack of comparable Canadian product, I found the ETF's were recently created. Therefore, little historical performance to evaluate, not to mention the increased foreign exchange rate exposure and witholding tax issues. Low cost USA mutual funds had much longer lifespans.

It appears very few Canadian investors actually buy USA ETF's although there are considerably more investors willing to talk about them. Perhaps things will change in a few years.
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Post by Shakespeare »

very few Canadian investors actually buy USA ETF's
Many of us here own them.
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Post by Bylo Selhi »

Shakespeare wrote:
very few Canadian investors actually buy USA ETF's
Many of us here own them.
Moreover, ETFs are the only practical way for non-US residents to buy low-cost index funds that are domiciled in the US. (It's very difficult, if not impossible, to buy conventional Vanguard funds if you're not a US resident.) For that reason alone I'm glad we now have the option to buy funds from Vanguard, BGI et al. I don't know how many other Canadians have availed themselves of this opportunity but the number can only increase as the word gets out.
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Post by AltaRed »

Bylo Selhi wrote:Moreover, ETFs are the only practical way for non-US residents to buy low-cost index funds that are domiciled in the US..... I don't know how many other Canadians have availed themselves of this opportunity but the number can only increase as the word gets out.
Other than some specific stock picks that I believe are excellent buying opportunities from time to time, virtually all of my US$ holdings will eventually be BGI, State Street or Vanguard ETFs. I've held SPY for a number of years now. I may be in a different situation than most because a considerble portion of my asset base is in US$ as a result of multiple work assignments in the US over the years.
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Post by Bylo Selhi »

Jon was on the CBC Saskatchewan morning show today to discuss his recent FP column about mutual fund fees. Here, through the wonders of the Internet (and your tax dollars) is the ~9 minute clip for listeners from coast to coast (and to coast so that even our peregrinating PM can hear yet again about the need for a national securities regulator.)

[url=rtsp://media.cbc.ca/cbc.ca/morningedition/media/20060817AUG_17_M.rm]Mutual funds - a good way to save for the future, or a blatant rip-off?[/url]

(Real Player (or better still the Real Alternative) required.)
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Post by The Wealthy Boomer »

Thanks, Bylo: handy link. And I do believe this very forum was mentioned there, as it was (allbeit obliquely) in today's follow-up column in the paper.

One thing however, I mention an MER fee impact calculator at www.ishares.ca. I'm told that is no longer "up" and they now refer investors to another MER calculator at the OSC's web site.

It's at www.investored.ca.

The full URL is http://www.investored.ca/en/interactive ... n=category
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Post by sydney2 »

I have been taking a look at some holdings in our non-reg account that have been there from our full service brokerage days. The one in question is Citadel Stable S-1, which was bought just after the initial IPO at $9.81. The dist. is 7%, current price $8.65.

I took a look at their top 10 holdings, and some of them I wouldn't consider holding as individual trusts, now that I am doing this myself, but 7% kept us holding it, with the thought that it would improve. There is still a trailer fee being paid to the original broker according to Citadel's website, I think I'm outta here......probably will take the loss and try to make it up somewhere else. Anyone familiar with this group of funds.

We were convinced to go with Mulvihill group at one time, and cleared out of those real fast, (Prem. Inc. pro-ams etc.) RBC was pushing these at the time.
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Post by Norbert Schlenker »

DanH wrote:
Norbert Schlenker wrote:The description in the paper of their TSC calculation is ambiguous. I don't see how you can conclude they have double counted.
From Mutual Fund Fees Around the World, pp 12-13 of the printed version (14-15 of the pdf):
Our measure of total shareholder charges (TSC) includes the expense ratio plus annualized loads. Because loads are paid when entering and exiting the fund, it is necessary to divide these loads over the investor's holding period. We assume a five-year holding period in our analysis. This also allows us to compute the back-end load, because these loads often decline as the holding period increases. To do this, we study, for each fund, the schedule of loads and obtain the load paid by an investor with a five-year holding period. Thus, we define total shareholder cost (TSC) as:

Total Shareholder Cost = TER + initial load/5 + back-end load at five years/5
Sorry, Dan, I've been away. While I agree that the formula allows both front and back loads to be added in when calculating cost, there is no evidence that the authors ever set both the second and third terms in the sum to non-zero values. Unless you can demonstrate that their data set includes Canadian funds where they did this, you can't claim - or even imagine - that they have double counted.

P.S. Suppose you were the author of the paper. How would you rewrite that formula to take into account that some funds are front loaded and others are back loaded?
Norbert Schlenker wrote:Whoa! Control for GST if you like because that is clearly outside the influence of Fido. But you can't just say, "Well, they pay 100bp for distribution in Canada vs. 0 in the US, so we'll just discount that difference." It's Fido's business decision to pay 100bp for distribution in Canada and not the US. You can't just wave it away, any more than you could wave away a business decision to buy all the portfolio managers Ferraris.
So, it's okay to wave away fees that U.S. investors pay to distributors? Wouldn't that also qualify as a "shareholder cost"? Bundled or unbundled, a cost is a cost. Based on the illustration they provided (re: U.S. and Canada comparison), it doesn't appear that they used any of the lower fee classes like I, F, or other low fee classes.
To take the Fido Japan example, anybody in the US can buy the no load (and low fee) version. How does one do that in Canada?
The Fidelity Advisor Japan C sold to U.S. investors includes a 1% annual 12b-1 (trailer) fee in its 2.26% MER. That's pretty much on par with Canadian A-series funds though the MERs are still a bit higher here.
Okay, so Fido sells what amounts to a DSC version of its Japan fund in the US and it has expenses comparable to the Canadian version. So, in the US, Fido has made a business decision to sell both a DSC version and a no-load version and the result in assets (figures from M* today) is

Fido Japan (no load) $1,765MM
Fido Japan (all loaded versions together, including the C) $159MM

i.e. the load versions have 8% of that market.

In Canada, Fido's business decision is that all versions, loaded or not, are available only through high cost distribution channels. Why shouldn't Fido Canada wear that black eye?
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CDN MERs vs. US MERs

Post by karen »

I think a number of people on this thread (especially Dan) would be interested in my paper published in the Canadian Journal of Economics in 2003 called "Expense Ratios in North American Mutual Funds" (Vol 36, No. 1., p.192-223) i attempt to explain the 50% mark-up on Cdn. MERs using the most common explanations (ie: lack of competition up here and smaller funds which don't take advantage of economies of scale) but find that those 2 explanations only account for 24% of the difference. the rest (76%!!) is "unexplained". in academic articles, you can't say that the advisors are being greedy but it is implied. in the final paragraph, i conclude that the difference is likely due to higher trailer fees in Canada as well as more back-loaded funds sold in Canada.

would like to post the paper but don't see an option for that here?
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links to article

Post by karen »

here's a link to my article in the Canadian Journal of Economics:
http://www.ingentaconnect.com/content/b ... .henrietta

hope that worked...

if not, i'd be happy to email a copy of the article to anyone interested.

Karen Ruckman,

Asst. Professor, SFU Business.
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Post by Norbert Schlenker »

Karen has emailed me the article and I've put it up on the server.

http://www.financialwisdomforum.org/gallery/final.pdf
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Post by Bylo Selhi »

Norbert Schlenker wrote:Karen has emailed me the article and I've put it up on the server.

http://www.financialwisdomforum.org/gallery/final.pdf
Thanks, Norbert and welcome aboard, Karen.

See also: Robert Mundell Prize
The Canadian Economics Association is proud to introduce the Robert Mundell Prize to the "young" author or authors of the paper judged to be the best paper published in the Canadian Journal of Economics in the previous calendar year...

The selection of the best article published in the years 2002 and 2003 was made by a committee consisting of Allan Gregory (Queen's University), Jane Friesen (Simon Fraser University) and Ralph Winter (University of British Columbia). The prize was awarded at the Canadian Economics Association Meetings in June 2004 to Karen Ruckman (Concordia University) for her article entitled Expense ratios of North American Mutual Funds, which appeared in the February 2003 issue of the Journal.
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Post by NormR »

Norbert Schlenker wrote:Sorry, Dan, I've been away.
FYI, Dan is currently away, don't expect a quick reply :)
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Post by The Wealthy Boomer »

Interesting study, Karen. Did the industry give you any feedback after it was published? Are things any different today?
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MERs

Post by karen »

there was no reponse from the industry at the time. i think they preferred to sweep it under the carpet.

my understanding is that nothing has changed since the paper was published (in 2003). there was a movement to make trailer fees transparent (as they are in the States) in the early 2000's in a policy paper by Marianne Stromberg but i don't think that anything has become of it. the higher trailers up here would explain part of the MER discrepancy but not all of it. but as long as they are hidden in the MERs, there's no incentive on the part of the industry to change things...why would they?

karen.
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Expensive, eh?

Post by tidal »

Expensive, Eh?

Article url above is about the previously cited study: “Mutual Fund Fees Around The World" updthread...

Article won't remain posted for long (a day or two...); nothing new relative to the study, but some amusing quotes:

"But we can be thankful for one thing: At least we’re not Canadian."

"From a global perspective, Canada’s expense ratios were simply out of line with established norms. The closest competitor was Luxembourg...
Wake up, Canadian investors! Look at the Dutch: They pay just 0.79 percent in fees. "
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Post by Bylo Selhi »

Mutual fund firms promise fee answers
James Daw wrote:Canadian mutual fund companies plan to answer claims of having the highest fees by far in the world. Members of the Investment Funds Institute of Canada agreed Tuesday to contact American and British researchers about their attempt to explain differences in the cost of selling and managing funds in 18 wealthy countries. "We will make a full public response by the end of September," said fund-industry spokesperson Susan Yellin. "We realize it's an important issue."...

Some Canadian observers suspect figures in the latest international study are exaggerated, but do not dispute that our fees are substantially higher and that small investors suffer if they blindly pay too much...

[Asst. Professor, SFU Business, Karen] Ruckman agreed in an interview that higher annual compensation for sales reps is the biggest factor, and that the higher compensation may encourage advisers to recommend costly funds to the detriment of clients. Ruckman [see http://www.financialwisdomforum.org/for ... 191#157191] reported in her study that the average management expense ratio among 1,455 equity and balanced funds in Canada was 2.29 per cent, 1 1/2 times the 1.55 per cent fee among 5,749 U.S. funds.

Glorianne Stromberg, a retired securities lawyer who wrote major reports on mutual funds, suspects fees would fall if Canadians could buy U.S. mutual funds directly. But laws in both countries keep out foreign funds unless the manager and sales representatives meet local registration requirements. Meanwhile, U.S.-based fund managers that charge low fees at home have struggled after setting up Canadian arms.

Eric Kirzner, a professor of finance at the Rotman School of Business in Toronto, said he has complained about Canada's higher mutual fund costs for years. There is no simple explanation, he says, but one answer is to educate investors about how high expenses cut into investment returns.
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Post by yielder »

Bylo Selhi wrote:Mutual fund firms promise fee answers
James Daw wrote:
Eric Kirzner, a professor of finance at the Rotman School of Business in Toronto, said he has complained about Canada's higher mutual fund costs for years. There is no simple explanation, he says, but one answer is to educate investors about how high expenses cut into investment returns.
No simple explanation? Sure there is. Terribly inadequate performance and expense disclosure. Who reads a prospectus? Glossies are a lot sexier. And probably not enough competition. Education is not as effective as making all promotional material carry net returns and gross returns with a footnote that says the difference is due to fund expenses. Show (chart if not both chart & table) the growth of $1000 on a net basis and on a gross basis. If all promotional material carries this kind of disclosure, investors are constantly reminded. Eventually it will sink in.
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