The search for low-fee
Smart purchasers are starting to eye
cheaper, better performers,
By ROB CARRICK
Globe and Mail: Saturday, June 26, 2004 - Page
What they don't tell you about fixing your funds portfolio:
After sinking close to half a trillion dollars into mutual funds, Canadian
investors' long-running love affair is cooling. Their ardour has wanted, as the
benefits of hassle-free investing and professional management are outweighed by
high fees and underperforming returns. Smart investors ready to fix up their
portfolios are considering such exit routes as exchange-trading funds and
low-fee products from boutique firms. We offer a guide t some easy ways to tune
up your investments.
Rick Clark used to have a portfolio stuffed with more than a dozen popular funds
from several of the big mainstream companies. Then he did a little reading up on
fees and how they were eating into fund returns.
"I just see [fees] as being way out of line," said Mr. Clark, a computer
programmer with Nortel Networks in Ottawa. "The best way to indicate that is to
vote with your feet, so that's what I did."
Convenient and practical, mutual funds are for many people the no-muss, no-fuss
way to invest. Proof of their mass appeal? Canadians now have nearly half a
trillion of their savings tied up in more than 5,000 different fund variations.
But mutual funds can be costly to own and their investment returns routinely
underperform. Which is why it may be time for smart investors to start eyeing
Mr. Clark still owns funds, but only ones with low fees.
Jim Steel's break with funds was more far-reaching.
Mr. Steel was a heavy user of mutual funds in his 11 years as a broker with a
big bank-owned firm. Then he took the Chartered Financial Analyst course, a
respected accreditation for financial professionals that exposed him to a theory
saying it's very difficult for individual mutual fund managers and investors to
beat the returns of the major indexes by picking their own stocks.
Now, Mr. Steel buys his clients exchange-traded funds, an increasingly popular
alternative to mutual funds that provide the returns of a variety of stock
"Mutual funds are terrible investments in my opinion," Mr. Steel said. "They're
just too expensive. You take a look at their performance and they underperform
their benchmarks, plus there's hidden fees. I don't know why anybody buys them."
Funds are riddled with problems that aren't apparent to many investors. This
week, the Report on Business series Mutual Funds: What They Don't Tell You has
shown that Canada's fund industry has in some cases not served the best
interests of investors. If it's not bloated fees that eat up returns, it's
shoddy self-supervision that opened the door at many firms for highly
questionable practices like market timing, where influential clients received
special trading privileges that undercut returns for rank-and-file clients.
All this may tempt ordinary investors to conclude, like Mr. Clark and Mr. Steel,
that it's time to stop being taken for granted by mutual fund companies and to
fight back. But what are the alternatives?
Essentially, there are three: Buy your own stocks and bonds, get out of the fund
industry's mass market mediocrity and into funds that combine low fees and top
performance, or try exchange-traded funds.
For most fund investors, choosing individual stocks and bonds is impractical; it
takes more time and knowledge than they have.
Mr. Clark went for the low-fee option. He sold his big-fee funds and moved into
the likes of TD Bond, BMO Dividend, the Trimark Fund and three funds from the
Saxon family, all of which have management expense ratios (MERs) that are way
And it happens in the fund world that low fees and good returns often go hand in
hand. Some prime examples: Phillips Hager & North, McLean Budden, Beutel
Goodman, Saxon Funds, Chou, Mawer, and Leith Wheeler.
"I think that pretty well covers the ground for what I would pinpoint as being
the really desirable boutique companies in Canada that fly beneath most people's
radar screen," said Gordon Pape, an investing expert who has been rating funds
for about 15 years. "They're all good. In fact, I own funds from many of them
Low-fee funds aren't just a plaything of analysts and savvy investors like Mr.
Camp. Some financial advisers also use them.
"We tend to pick funds where, as much as possible, they are low MER," says
Warren Baldwin, a fee-only financial planner with T.E. Financial Consultants
Ltd. in Toronto. "If we're doing a retail fund portfolio, an obvious example of
what we'd use would be a family like Phillips Hager & North."
Mr. Baldwin says focusing on MER is critical because investors need to know what
they're paying in order to decide whether they're getting good value. One way to
do a quick value check is to use the mutual fund fee impact calculator offered
by the Investor Education Fund Web site at http://www.investored.ca.
Be warned: It can be hard to find an investment adviser who sells low-fee fund
families because they pay little or nothing in fees and commissions (that's a
big reason why their MERs are low). To get an adviser on side, you may have to
pay him or her a commission of 1 to 2 per cent of your investment. Discount
brokers and fund dealers usually sell these funds, but they may also charge a
small upfront fee.
Scraping together enough money may also be a problem. Each of the fund families
mentioned above has a much higher minimum upfront investment than the average
fund company's $500 or $1,000. PH&N requires $25,000, although you can spread
that into several funds that can comprise a balanced portfolio. Saxon and Mawer
are on the low end at $5,000, while Leith Wheeler requires a minimum of $50,000.
The high minimum investments are part of a corporate culture of frugality at
these fund companies that results in MERs that are generally way below industry
averages. By screening out multitudes of small accounts, administration costs
are reduced. Most of these companies do almost no marketing and, as noted, they
pay next to nothing in commissions to dealers and advisers.
The small fund companies mentioned earlier excel in most cases, but a few
heavyweight companies with low investment minimums do reasonably well, too.
Among them are Franklin Templeton and Fidelity, as well as three bank families
-- BMO Investments, RBC Asset Management and TD Asset Management.
Funds from these and other companies that represent good value include: Canadian
Equity: RBC O'Shaughnessy Canadian Equity, ABC Fundamental Value, PH&N Canadian
Equity, Saxon Stock Canadian Dividend: PH&N Dividend Income, Scotia Canadian
Dividend Canadian Bond: PH&N Bond, Beutel Goodman Income, McLean Budden Fixed
Income, Legg Mason Canadian Active Bond Canadian Balanced: CIBC Monthly Income,
RBC Monthly Income, McLean Budden Balanced Growth, Trimark Income Growth (SC
version) U.S. Equity: Chou Associates, Mutual Beacon Global Equity: Mackenzie
Cundill Value, Mackenzie Cundill Recovery, Saxon World Growth, Trimark Fund (SC
It's worth noting that some fund families that offer solid value also
distinguish themselves in the area of governance. For example, both PH&N and TD
Asset Management have tried to discourage market timing by levying fees on
market timers who redeem money in the period just after buying.
Mr. Steel has dumped funds altogether and entered a long-term relationship with
ETFs, which track dozens of widely followed stock indexes in Canada and around
the world. Each ETF unit -- you buy them on stock exchanges -- represents a tiny
holding in every stock in the underlying index, be it the S&P/TSX composite, the
S&P 500, the Morgan Stanley Europe, Australasia and Far East Index and so on.
While it was investing theory that got Mr. Steel to think critically about
funds, it was the real-world experience of looking at his clients' accounts that
cinched his decision to move into index-tracking ETFs.
"I went back and I looked at the returns I was getting clients in mutual funds,
individual stocks and wrap accounts," said Mr. Steel, who works at PWL Capital
Inc. in Ottawa. "I couldn't say I was doing any better than the indexes."
The most popular ETF in Canada, the iUnits S&P/TSX 60 Index Fund, or i60 (XIU-TSX),
has an MER of 0.17 per cent. A comparable large Canadian equity fund holding
mostly blue chips would average around 2.4 per cent.
This means that you would make whatever the S&P/TSX 60 index does in a given
year less 0.17 of a percentage point, or whatever your Canadian equity fund
manager can achieve minus 2.4 per cent. Some managers will undoubtedly beat the
index over a given period, but an indexing advocate would counter that it's too
hard to predict which funds will outperform.
Index mutual funds sold by the banks do pretty much the same thing as ETFs, but
at higher MERs that make them far less attractive. One exception is the e-fund
series from TD Asset Management, which is available only over the Internet from
TD directly or through on-line broker TD Waterhouse. You can get index funds
that track major Canadian and U.S. stock indexes with MERs as low as 0.31 per
One of the difficulties in making a clean break from underperforming mutual
funds is the cost. If you bought your funds through an adviser with a deferred
sales charge (DSC), and the vast majority of funds are sold this way, then you
could be subject to redemption fees.
Most fund companies have a sliding fee scale that starts at 5 or 6 per cent in
the first year and declines to zero after the sixth or seventh year. If you're
trying to exit a few disappointing funds, you could easily rack up charges that
drag your returns down even further.
Here are some options for getting out of DSC funds, supplied by Jack Di Nardo,
an adviser with WealthWorks Financial Inc. in Richmond Hill, Ont.: The
10-per-cent rule: Most fund companies let you sell or transfer out 10 per cent
of your holdings a year with no redemption charges. Some companies apply this
percentage to your original investment, others to a more current valuation.
Switch to something better: It's often possible to switch to a better fund
within the same family without triggering a redemption fee. For new clients with
smaller accounts, Mr. Di Nardo would charge a 1-per-cent switching fee to cover
the cost of his efforts in getting the switch done.
The commission rebate: The adviser sells the client's DSC funds and moves the
assets into new funds elsewhere. He then takes his upfront commission for
selling the new funds and uses it to offset the redemption charges on the old
fund. Each dealer may have specific rules that discourage such transactions, Mr.
Di Nardo said. "I'm willing to do this and I think there are a number of
advisers who are, but I know that some people are very inflexible on this."
Mutual funds will always be the investment of the masses, if only because
they're an easy answer for people without the time, knowledge or inclination to
build their own portfolios from scratch. Just remember that if you fall out of
love with your funds, you do have options.
Beutel Goodman Investment Counsel:
Minimum Initial Investment: $10,000
Fund Highlight: Beutel Goodman Income - above average returns for eight straight
Contact: http://www.beutel-can.com or (800) 461-4551/(416) 485-1010
Chou Associates Management :
Minimum Initial Investment: $10,000
Fund Highlight: Chou RRSP - its 10-year return is more than double the average
Canadian equity fund
Contact: http://www.choufunds.com (under construction)_(416) 367-4941
Leith Wheeler Investment Counsel:
Minimum Initial Investment: $50,000
Fund Highlight: Leith Wheeler Balanced - consistently better-than-average
Contact: http://www.leithwheeler.com or (888) 292-1122/(604) 683-3391
Mawer Investment Management: Minimum Initial Investment: $5,000
Fund Highlight: Mawer Canadian Balanced RSP - reliably better-than-average
Contact: http://www.mawer.com or _(888) 549-6248 or (403) 262-4673
Minimum Investment: $10,000
Fund Highlight: McLean Budden American Equity - one of the best long-term
performers in the U.S. equity category
Contact: http://www.mcleanbudden.com or (800) 884-0436/(416) 862-9800
Phillips, Hager & North Investment Management:
Minimum Investment: $25,000
Fund Highlight: PH&N Dividend Income - one of the best funds in the country,
Contact: http://www.phn.com or _(800) 661-6141/(604) 408-6100
Saxon Funds Minimum Investment: $5,000
Fund Highlight: Saxon World Growth - strikingly superior returns over the past
Contact: http://www.saxonfunds.com or (888) 287-2966/(416) 979-1818
Follow the mutual fund series this week on website http://www.globeandmail.com