Saturday, January 18, 2020

Mutual Fund Costs not in the Spotlight

The high cost of having a financial advisor has been in the news lately. A recent example is Jonathan Chevreau’s discussion of the problems with Deferred Sales Charges (DSCs) and the future of financial advice. The banning of DSCs everywhere in Canada except Ontario is reshaping how financial advisors get paid. However, this discussion only covers a fraction of the costs mutual fund investors pay every year.

Mutual fund companies silently dip into Canadians’ mutual fund savings every year for a percentage called the Management Expense Ratio (MER). Too often, this is 2% or more. This may not sound like much, but when you lose 2% of everything you have saved every year, it adds up quickly. Over 25 years, about 40% of your money is gone.

Out of this MER, mutual fund companies pay financial advisors roughly 1% to choose their funds for investors. The remaining money from the MER goes to the fund company. But what do they do for their money?

Most of the largest mutual funds in Canada don’t even bother to try to pick good stocks. They are known as “closet indexers.” They just choose most of the stocks from a given index and collect their fees. With the biggest mutual funds, investors pay the fund company tens of millions of dollars and get little for their money. At least advisors do something for the tens of millions of dollars investors pay them.

Not all mutual fund companies are closet indexers. There are some that make a meaningful effort to choose good stocks and keep costs low. However, if your advisor hasn’t brought up how he or she gets paid, it’s likely you’re paying high costs to both your advisor and your mutual fund company.

Despite all the attention advisor fees are getting lately, this part of what investors pay in fees is somewhat useful. The money investors pay their mutual fund companies is usually a complete waste.

7 comments:

  1. Yes, most Canadian mutual funds from the likes of RBC and their salesmen (who are euphemistically called “advisors”) are atrocious.

    Steadyhand, Mawer, Tangerine, Beautel Goodman are better.

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    1. BHCh: Yes, I was looking at an RBC Canadian equity fund. It never beat its index once in the past 10 years. Nearly always trailed by roughly its MER. Rent-seeking.

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    2. Yes, I had a “conversation” with an RBC saleswoman about 5 years ago. She told me 2% MER was low. And that the fund she was pushing was guaranteed to outperform because the manager was so clever. It was atrocious.

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  2. Oh, and she told me that by refusing to buy the fund I was “forfeiting her valuable and free advice”.

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    1. BHCh: That definition of "free" reminds me of a story from my father. When he and my mother bought a house for $11,500, they were told that if they paid $15,000, they'd get a free car with it.

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  3. Tom Bradley at Steadyhand sent me the following comment:

    Michael, with regard to your recent blog … it's important to keep the advice and fund management costs separate. I agree that there's way too much 'closet indexing' and that the total fee for most investors is too high, but the product cost is a small part of the problem. 'F' series fund fees are coming down and are quite competitive with the specialty ETF MERs.

    Today, if an investor wants advice, whether they use ETFs, mutual funds or individual securities, they are paying a king's ransom (for advice). An ETF investor who uses an advisor may also be close to 2% all in.

    Yes, some 'active' funds are frauds, but the real culprit here is the cost of advice.

    Keep well,

    TB

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    1. @Tom: Thanks for your insight. I'm hopeful that closet indexers are becoming less of a problem. Sadly, it's some of the biggest mutual funds that continue to charge active fees but hug the index. Looking past high-cost closet indexing, I agree that the high cost of "advice" is a major concern. I'd like to think that the current focus on advice costs will make a positive difference. I'm also hopeful that if we get advice costs under control, this will help take care of unreasonably expensive mutual funds. I'm not holding my breath though.

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