By Dan Hallett, CFA, CFP
A few years ago, a research paper by three academics claimed that Canadian mutual funds levied higher average fees than funds in seventeen other countries. Since average Canadian fund fees are high, the media jumped all over this research – despite being incomplete. Reading through many versions of the paper, it became clear that the core data and underlying assumptions were questionable.
Given that inaccurate figures from the paper were being quoted in otherwise reputable publications, I wrote detailed critiques on this paper in this 2006 article and in this piece from 2008. I felt like the lone public voice warning against quoting research on global fee comparisons that hadn’t attempted to tease out regional differences in disclosure and advisory fee structures. So, I was pleased to see a recent article in The Telegraph slamming the British fund industry for hidden charges that can double or triple published expense ratios.
The article appears to validate one of my concerns with the earlier academic research article. In particular, the Telegraph article states:
When a saver invests in an ISA, unit trust or other fund, they are informed that they will pay an “annual charge” – typically 1.2 per cent of the value of their savings. The majority of funds levy exactly the same charge.
But the firm also deducts a range of other vaguely defined fees – covering everything from research to office costs from the savers’ money [similar to Canadian operating expenses].
In particular, funds charge savers fees and commission every time they buy or sell shares. In some funds, hidden fees can be more than three times higher than the publicly-released annual fees.
These fees are nothing new to Canadians; they are operating expenses and costs incurred by funds when trading stocks. But a more complete total cost calculation offers interesting insight.
The Telegraph article uses Morningstar data in citing a typical expense ratio of 1.7% for U.K. funds. The article further pegs typical trading commissions at another 1.35% per year. By comparison, Canadian expense ratios are higher – I calculated 1.9% for all funds or about 2% excluding money market funds – but trading commissions are seemingly half of the U.K. figure found in the Telegraph article.
I haven’t done a study of U.K. fund fees but on the surface, this Telegraph article simply confirms my central critique of the academic paper – i.e. total shareholder costs weren’t equitably counted across all countries studied.
The academic paper, which used 2002 fee data, shows U.K. expense ratios at 1.3% vs. 2.2% in Canada. If we add the above trading commission estimates we get total fund costs of 2.6% in the U.K. compared to 2.8% in Canada. Only looking at expense ratios, Canada appears to be almost twice as expensive as the U.K. A more complete fee picture, however, makes them almost identical. Canadian fees may even be more competitive using more current data.
Then there is the issue of advisory fees, which are mostly embedded in Canadian fund fees so they’re counted more than in fund markets like the U.S. or the U.K. But the academic study did not attempt to count advisory fees that investors pay separately on lower-fee funds. I have no doubt that U.S. funds are hands-down the world’s cheapest. While Canadian fund fees are higher than I’d like, on average, I can’t help but speculate that Canadian funds are more competitive than we realize when all costs are counted.
My aim isn’t to defend the fund industry. I simply maintain that no study is sufficiently complete to make meaningful global comparisons of the total costs that investors bear to invest in and hold mutual funds. Until that happens, any statement regarding where Canadian fund fees rank among its global peers is simply speculation.
More importantly, I’ve argued that the debate over average fees is simply academic. In the April 2008 issue of Investment Executive I reason that average fees don’t matter if we have enough breadth of choice to satisfy do-it-yourself investors and advice-seeking investors (whether their advisors are paid by commissions or separately-billed fees). In other words, averages are meaningless if everyone has what they need.
(Post Script: For a related story, see Canadian Fund Fees Revisited which was published shortly after this post.)
[...] This post was mentioned on Twitter by Jonathan Chevreau, Jonathan Chevreau, Indelible Bonobo, The Wealth Steward, Cameron Passmore and others. Cameron Passmore said: RT @DanHallett: Cdn funds world's priciest? Unlikely http://bit.ly/9l2Sfe [...]
Dan
Good analysis in the post and links, as usual. I agree with you that there are a host of measurement issues that make international comparisons of fund fees problematic, including the fact that the level of disclosure may vary from country to country as you suggest in this post.
Still, I remain somewhat concerned Canadians are being overcharged for mutual fund fees when I see things like prohibitions preventing Canadians from buying U.S. mutual funds, and DIY clients at discount brokerages being compelled to pay trailer fees on F-class funds. I’m not sure what the rationales are for these restrictions but do have suspicions they preserve some degree of pricing power on the part of fund companies.
Thankfully there is a free market, and other companies have emerged to provide additional choices such as directly-sold funds and ETFs. It’ll be interesting to see how far the process of consumer substitution goes — i.e. whether or not fund companies will be able to maintain some degree of pricing power.
Thanks for your message Larry. You raise some points that are worthy of some discussion – though I admit definitive answers may remain elusive.
The notion that Canadians are overcharged depends, I think, on your perspective – or perhaps on your circumstances. I’m interested in your perspective on this.
Do you think that everybody is over-charged or just those who use an advisor? If the latter, is it clients of fee-only advisors, clients of commission-based advisors or both?
[...] Dan Hallett: More evidence that Canadian mutual funds are not the most expensive in the world [...]
Larry,
you make points that are true in theory.
But it seems it’s the U.S. regulators who prevent Canadians from investing in U.S. mutual funds.
As for DIYers getting access to F-class funds at discount brokers, I haven’t seen any. (If you have, I’d love to know!)
The closest I can think of is RBC D-class funds, where the MER drops, for example, on RBC dividend from 175 bps to 114 bps. But there’s no additional trailer.
Scott B.
I’d be interested in some references or sources that would indicate US regulators prevent Canadians from investing in U.S. mutual funds? My understanding has been that the prohibition originated in Canada. Here is one source for that view: http://www.bylo.org/usmfcan.html.
Maybe I should rephrase the point about F-class mutual funds. They are offered by fee-only advisers without trailer fees. But discount brokers do not offer them without the trailer fees — even though the services of an adviser are not provided. Why so? To cite just one source: “Many fund companies have blocked the sale of F-class units through discount brokerage accounts in order to appease financial advisors who would be threatened by this practice.”
I can’t say that I know the origins but I started as an advisor in 1994. At that time, I was permitted to take on American clients – which I did. But that came to a screeching halt in 1996 when we were forced to liquidate and wind-up all of those accounts. At least one case that influenced it was when the SEC pursued a western Canadian brokerage for dealing with a contingent of clients in Arizona.
Similarly, in the late 1990s I knew of many people that held accounts directly with Vanguard or with brokerage firms (i.e. Jack White, Waterhouse [before TD bought them], etc.). So, it seems our respective markets became closed to each other’s residents at roughly the same time, though some firms acted more quickly than others.
As for F-series funds, it would make sense to make those available through discounters. I’d like to buy some of them personally. But I can’t. But this may be a case of “be careful what you wish for“. Between my own observations, research and the body of psychological research it seems pretty clear that too many choices leads to poor decisions and dissatisfaction.
So, to DIY investors, I’d ask: isn’t there already enough choice available from all of the 100+ Canadian no-load funds and 1,000+ North American ETFs? What else is needed? And what good will it do to have so much more from which to choose?
Load fund companies make a business decision. They will sell their funds through financial advisors. They will sell through discounters but not at a discount price. The only way to change that is for DIY investors to stop dumping so much money into more expensive funds. Until that day, it’s hard to blame any business for taking money that customers willingly hand over.
Dan
In response to your questions:
In collusive or cartelized industries, the price of the product is held above market-clearing rates through various restrictions. And those higher prices benefit not just the cartel but also the non-cartelized providers that follow the price leadership of the cartel.
I’m not saying the mutual-fund industry in Canada is tacitly collusive or cartelized, but there seem to be hints of such, considering some of the restrictions placed on the choices of Canadian investors. For example, according to several sources, it appears mutual-fund companies have blocked discount brokerages from selling F-class funds without trailers fees.
But markets are usually in a state of flux and choices have emerged for financial consumers, thanks in large part to the entry of ETF companies. This suggests, to me, anyways, that the final arbitrator in the discussion over whether or not the mutual-fund industry charges too much for its package of active management/financial advice will be the market.
In other words, if service is truly not commensurate with price in the mutual-fund industry, there could be a broad migration toward the emerging alternatives. And at present, the market seems to indicating that is a possibility — as I recall, growth rates for ETF assets have been noticeably surpassing those for mutual funds.
This could very well change. Indeed, the cynic would say, in other cartelized industries the response sometimes has been to rein in competition in various ways, such as acquiring new entrants or marshalling financial depth to subsidize entrants that engage in ruinous competition. But, for now, the message implicit in current market dynamics seems, to me at this stage, more supportive of the alternatives.
Dan
I posted my previous post before reading your last post.
That is, it was a response to your first post.
Larry,
My recollection of these debates goes back to the late 1990s and early 2000s where the then-IDA was seeking mutual recognition with U.S. state regulators. Just as, in bylo’s summary, Canadian regulators were reluctant to extend recognition to U.S. firms not registered in Canada, U.S. state regulators were reluctant to let U.S. residents transact in Canadian-domiciled registered accounts — even if they were Canadian citizens.
http://www.garygauvin.com/WebDocs/IDA_RRSP_Info.pdf
It was a bit of a tit for tat, or a regulatory turf war: “Unless registered in the U.S., Canadian mutual funds and other securities in a public offering cannot be offered or sold to Canadians temporarily resident in the United States outside of Canadian self-directed tax advantaged retirement plans since such offers are part of a continuing public offering.”
I found it a hoot at the time that neither country trusted the other country’s regulators to root out the bad guys.
[...] donnée fait dire à Dan Hallett qu’il est faut de « prétendre que le Canada est le pays le plus coûteux pour les investisseurs [...]
[...] Wealth Steward finds more evidence that Canadian funds “are not the world’s most expensive.” [...]
As Dan points out, it used to be OK for Canadians to open accounts with US brokers as well as directly with US fundcos. (I had both.) Then our provincial securities regulators fined TDW US, Ameritrade and Datek $800k each for doing business with Canadians.
But then shortly afterwards something big happended on 11Sep01 that begat the PATRIOT Act and similar legislation up here. Thereafter US fundcos, e.g. Vanguard, first became very cool to their Canadian customers and then insisted that we repatriate our holdings to Canada. (FWIW Vanguard wouldn’t even let me open a VBS account long enough to convert my VTSMX open end to the ETF share class VTI!) So regardless of the tit-for-tatting by regulators, the fallout from 9/11 was instrumental in ending all hope of cross border trading any time soon.
As for F-class funds and the contention that “too many choices leads to poor decisions and dissatisfaction” then maybe the fundcos could also eliminate about 80% of the rest of their funds
Discount brokers are legally prohibited from offering investment advice. Fundcos justify the extra costs of their trailer fee based funds on the basis that this includes investment advice. They’re being inconsistent when they preclude the discount brokers from offering F-class funds because investors are being forced to pay for advice that their brokers aren’t allowed to provide. The securities regulators, who claim to act in the interest of investors, should long ago have ended this implicit collusion between DBs and fundcos.
All that said, there’s now far less need for Canadians to use US brokers, because (a) ETFs are now available via Canadian brokers that track almost all asset classes and (b) Canadian discount brokerage fees have dropped in line with their US counterparts.
More on this issue from Advisor.ca in a story about a research paper by Bain & Co., commissioned by Mackenzie Financial.
[...] few weeks ago, I resurfaced my arguments against concluding that Canadian mutual fund costs exceed those of all other developed countries. [...]