Investors can be forgiven for being puzzled over the wide difference between the costs of various mutual funds and exchange-traded funds. Take, for instance, two funds – one, a segregated mutual fund with a whopping 3.6% MER but a money-losing track record with a dismal annualized loss of -6.27% over the past five years (to June 30); the other, a passive, broad-index-tracking ETF with an annualized return of 4.21% in the same period and a virtually invisible MER of 0.05%. Why the enormous variance, and is the high MER totally to blame?
The Equitable Life Acuity Pure Canadian Equity Fund B is the segregated fund in question, while the iShares S&P/TSX Capped Composite Index ETF (TSX: XIC) is the ETF.
The MER is the total of all operating expenses and management fees paid by an investment fund expressed as a percentage of the fund’s assets. Management fees are charged to the fund by the fund’s managers, while the fund pays operating expenses such as legal and accounting costs, custodial fees, and other administrative expenses. The total of all these fees and costs is known as the MER.
MERs vary from fund to fund, ranging from as low as 0.05% for some passive index-tracking mutual funds to over 5% for some types of segregated funds. Generally, funds with more complicated or more active management have higher MERs, because the managers do more research or trade more actively (which raises transaction costs) in search of better performance, and so on. Funds with guarantees (like segregated funds) have higher MERs, because of the cost of the insurance premium involved, which pays for any guarantees, as may be the case in the Equitable Life fund.
The price of a capital guarantee built into the MER of a segregated fund is a high price to pay for long-term underperformance. But that has more to do with management style, investment selection, and the fund’s mandate than with a high MER.
Exchange-traded funds (ETFs) tend to have lower MERs than mutual funds. Management fees and operating expenses are kept to a minimum because most ETFs passively track an index of some kind, so there’s no need to pay a fund manager to incur expenses in researching and trading securities. ETFs that track so-called active indexes generally have higher MERs relative to true passive ETFs owing to higher transaction and other costs incurred when changes are made to the underlying index. For example, the Horizons Active CDN Dividend ETF (TSX: HAL) delivered a 5-year annualized return of 6.96%, but with an MER of 0.70%.
Investors do not pay the MER directly. Rather, it is deducted from the assets of the fund, in effect reducing the fund’s – and ultimately your – return. A high MER is a serious hurdle for both managers and investors, so it’s crucial to look at a fund’s performance data in conjunction with its MER before investing. Is the fund actually delivering long-term performance that warrants a high MER? It’s simple: If it isn’t, don’t invest.
Note, though, that a low MER doesn’t translate automatically into better returns. A fund with an 8% return and a 2% MER still delivers a better return than a fund generating a 4% return with a 1% MER.
Courtesy Fundata Canada Inc. © 2016. Robyn Thompson, CFP, CIM, FCSI, is president of Castlemark Wealth Management. This article is not intended as personalized advice. Securities mentioned are not guaranteed and carry risk of loss. No promise of performance is made or implied.
