Published
MERs can be misleading
With future
returns expected to be substantially lower than in the past, more investors are
paying attention to the fees attached to their investments. If you checked out
some of the free mutual fund filters on web recently and tried to find low fee
funds, you probably saw a long list. However, most of the funds with the lowest
published fees are not what they seem.
Mutual
funds traditionally charge a management fee for the day-to-day decision-making
and management of the fund, and operating expenses to cover things like
accounting, legal and other administrative costs. The total of the two is what
is commonly referred to as the management expense ratio (MER). Since most funds
are sold through financial advisors, the management fee is set at a level that
compensates the fund sponsor for their costs, in addition to paying the
financial advisor’s firm for their work, and a little profit margin on top of
all that. It’s all built into one fee, which means that it’s all bundled
together.
Hence, a
fund that has unbundled fees charges only the operating expense portion
(ranging from 0.10 to 0.50 per cent per year) directly to the fund. In such a
case, management fees are charged separately from the operating expenses on
some kind of scale (i.e. lower for larger investments) and are usually invoiced
directly to the investor. While this structure has its benefits (i.e.
transparency of costs and slight tax advantage), it can be misleading when
included in the same context as regular mutual funds, which charge all
management and operating expenses directly to the fund.
Since the
only fees charged to these funds are operating expenses, that’s the only thing
that is included in the “published MER” that you’ll get from many mutual fund
data providers. The Ontario Securities Commission’s National Instrument 81-101
(http://www.osc.gov.on.ca/en/Regulation/Rulemaking/Rules/81-101_ni.html)
states that a prospectus must report the MER based on all costs charged to the
fund. However, if the management fee is not charged to the fund (but instead to
the investor directly) it will never show up in the MER.
Funds
included in this group are mainly pooled funds such as Acuity Pools, Beutel
Goodman Private funds, McLean Budden Pools, Montrusco, and SEI funds. Also
included in this group are pooled funds only available through wrap programs,
such as Optima Strategy. See my May 14, 2001 article (http://www2.myto.com/money/tidd_fs.cfm?source_id=&id=836292)
for details on Optima Strategy funds. Other funds such as those offered by
Integra Capital Management (ICM) also fall into this group of funds, which
charge management fees directly.
For those
funds that do charge management fees at the fund level, there may still be some
discrepancy between actual fees and what you see on free mutual fund data
services. While a fund’s prospectus must show all fees charged to the fund,
some fund firms may simply not send this data to mutual fund data providers,
which typically don’t audit the data for accuracy or legislative compliance.
Also, funds
that are brand new can only report an “official” MER figure once the fund has
completed a full year of operation. While the management fee is known in
advance, it’s impossible to know exactly what a fund’s operating expenses will
be a year in advance. In a case like this, only the management fee is reported.
(Many Internet sites and newspapers will use notation to alert investors that a
fee includes only the management fee portion. For instance, a MER listed as
“2.00%m” means that this fee includes only the management fee, which is 2 per
cent of assets.)
You’ll be
pleased to know that, sometimes, fees are lower than you expect. Many fund
sponsors will absorb a portion of the fees on their smaller funds until they
reach a level of assets such that the total fund fees are at a level that is
comparable to other similar funds. For instance, when Scudder first launched
their Canadian funds, they actually absorbed all of the management and
operating expenses of all funds for the first year. Had they not done this,
some of their funds would have reported MERs in excess of 9 per cent. As their
funds grew in size, Scudder absorbed less and less of the total fees until they
could be charged entirely to some of their larger funds and still stay competitive.
It’s
important to use the simplified prospectus as a core source of fund
information. Maximum fees are shown in the fund-specific information section in
a table entitled “Ratios and other Supplemental Information”. The prospectus’
section on general information and fees should also give you enough information
to judge whether or not additional fees apply. If it’s still unclear, ask a
representative of the fund sponsor or your personal financial advisor.
Different
fee structures are fine, as long as you know what you’re paying.
Dan Hallett, B.Comm.,
CFP is Senior Investment Analyst with Sterling Mutuals Inc. He can be reached
at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, and Manitoba.