Friday, October 26, 2007

What is an MER?

The people who run mutual funds have to eat. They also have to pay commissions to the people who sell units in mutual funds to the public. Other expenses include the cost of buying and selling stocks and paying for those slick commercials on TV scaring you into believing that you can’t do this investing stuff alone.

Where does the money to pay for all this stuff come from? Well, mutual fund managers could look for nickels on the sidewalk, but it’s easier to take some of the giant pot of investor money invested in the mutual fund. The percentage of investor money taken for these expenses each year is called the Management Expense Ratio, or MER for short.

A quick look through the Morningstar data on mutual funds shows that for U.S. funds holding at least $100M of investors’ money, the MERs tend to be around 1%. There is some variability, though. For example, the Vanguard 500 Index only charges an MER of 0.18% per year, while the Alpha Hedged Strategies Fund charges 3.99% per year.

In Canada, MERs tend to be much higher. According to the data, the average Canadian Equity Fund holding at least $100M of investors’ money charges an MER of 2.2%. This average drops to 1.9% when we weight it by the size of the fund. This means that big funds tend to charge lower MERs. Either way, Canadians pay a lot more than Americans.

As in the U.S., the MERs charged by Canadian funds tend to vary from fund to fund: for example, the iShares CDN LargeCap 60 Index Fund charges 0.15% per year, and the Trans GS Canadian Equity Fund charges 4.23% per year.

When mutual funds report their investment returns, the MER is subtracted first. This is good in one way because the reported returns are what the investor actually receives. On the other hand, this tends to hide the MER from the investor’s view. In the next instalment, we’ll discuss why investors should care about the MER.

This is part 1 of 2 parts. Next part.

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