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Dan's Reports
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Privacy Policy


Phantom Fees
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.

Unbundled Fees

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 11, 2001 article (05/11/01) 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.

Non-reporting funds and new funds

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.)

Subsidized fees

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 prospects' 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, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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