In a bustling underground shopping concourse, the red and yellow letters flash rapidly to catch the eyes of bargain-hunters. “Just lowered...to 0.5%!!!” shouts the electronic message board from inside the plate-glass storefront of a Royal Bank Financial Group investor centre in Toronto’s financial district. It’s an unusual pitch, but so is what’s being promoted: reduced mutual fund fees.
Until now, price competition has not been the name of the game for the fund industry’s dominant players—the large independents selling through brokers and dealers, the banks and market leader Investors Group Inc. Throughout a decade of spectacular growth in sales and assets managed, the industry giants have competed aggressively on fund types and investment styles, on services, and on lucrative commissions to salespeople. In short, on just about everything except fees. But those electronic signs indicate a change in the wind. Suddenly, financial-service rivals are battling one another with low fees on a group of boring but inexpensive funds that mimic market benchmarks such as the
Toronto Stock Exchange 300 composite index. As well, the discount brokerages are competing by offering rebates on “back-endload” mutual funds, which typically charge clients a commission if they sell within six or seven years of their initial investment.
The mutual fund industry has started these price wars in the belief that there is a
At long last, a price war erupts in the mutual fund industry
small, attractive market of fee and rebate shoppers at the moment, and a trend to comparison shopping on its way. But there has been no widespread consumer demand for cuts. In fact, there is a surprising level of ignorance about all costs attached to mutual funds. “People don’t understand the fees and charges,” says Glorianne Stromberg, author of a report released last month that calls for tougher regulation of mutual funds. “They don’t even understand what they are
paying by way of commission.” According to a recent Royal Trust survey, 72 per cent of RRSP investors holding mutual funds didn’t know that a management-expense ratio (MER) is the percentage of fees and expenses levied against the assets of a mutual fund.
Canadian investors are also not likely to know that they have been paying much more for fund services than their American neighbours. A study released in July, 1998, by the Boston-based consulting firm Cerulli Associates Inc. found that management-expense ratios on longterm Canadian mutual funds were double those in the United States. On average, according to Cerulli, Canadian funds charged management fees of two per cent, compared with 0.94 per cent in the States. Though there are greater economies of scale south of the border, Cerulli said the main reason for the fee gap was that Canadian customers have been willing to pay higher fees.
The flip side of the Royal Trust survey is that 28 per cent of Canadian mutual fund investors are aware of expense ratios and make a likely target audience for low-fee index funds. In an industry that has grown to $394 billion in assets, this is a significant customer base. Among the most successful
index-fund sponsors making waves on fees is CIBC Securities Inc. By setting its MERs at 0.9 per cent, and offering a wide array of choices in index funds, the CIBC mutual fund operation has vaulted to a market-leading $1.5 billion in index-fund assets in a little more than two years, overtaking established players Toronto Dominion Bank, Canada Trust and Bank of Montreal.
Now, archrival Royal is seeking a big piece of the index-fund pie. CIBC’s rapid rise, and the prospect of a merger with Toronto Dominion Bank that would have created an indexfund powerhouse, finally jolted Simon Lewis, president of Royal Mutual Funds Inc., into action. “I really didn’t have any choice,” says Lewis. “We had to get into the game.” An active investor himself—the TV in his fifth-floor
Toronto office is tuned to the stock-ticker channel—Lewis has stated in the past that he is not a fan of index funds. His firm, which is the leading bank-fund group and second in the industry behind only Investors Group, was the lone holdout among the big banks on index funds. Now, with the blessing of Royal Bank chairman John Cleghorn, it has taken one of the most aggressive stands on fees. ‘When Pepsi comes into the Coke market, the first thing you do is get aggressive on price,” says Lewis.
The Royal made its move last fall when it launched six index funds and became the new price leader with MERs of 0.55 per cent. But that lasted only for a few weeks. Independent direct seller Altamira Investment Services Inc. undercut the mighty Royal in November with expense ratios of 0.5 per cent, briefly becoming the lowest-cost provider of index mutual funds. It was a departure for
Altamira, noted for aggressive fund management rather than low fees. ‘We think it’s important to give our clients choice,” says Altamira president Gordon Cheesbrough, whose do-it-yourself clients are often more knowledgeable about fees than the general fund-buying public. “Fees have become an issue,” says Cheesbrough. “You read about them. Clients talk about them.” Royal countered a day later by matching Altamira. Vows Royal’s Lewis: ‘We’ll go as low as we need to stay competitive.” CIBC decided not to match Royal’s fee cuts directly, opting instead to undercut Royal only on the largest and most profitable accounts of $150,000 or more. CIBC Securities CEO Ted Cadsby says its index funds were more affordable anyway, requiring only a minimum $500 purchase,
rather than the $2,500 minimum insisted on by Royal and $5,000 at Altamira.
In some quarters, the fund wars have led to a re-evaluation of how the game is played. Toronto Dominion Bank’s mutual fund arm, for one, has held the line on its index-fund fees, but is in the midst of some heavy-duty brainstorming. ‘We will not immediately respond, but when we do, it will be in an industry-breaking way,” says Mark Wettlaufer, president of TD Asset Management Inc. Wettlaufer says TD is looking at how it can reduce distribution and administrative costs and share those savings with customers. Inertia among consumers is giving TD and others time to cut fees. Even the institutions admit there is little immediate market demand. CIBC’s president Cadsby says: “I don’t think there’s a big customer demand for lower fees, let alone an awareness of the impact of fees on returns.” But Cadsby adds
that he expects consumer pressure to grow over the next 18 months.
Among managers of load funds, there are early signs of strategic moves in response to falling index-fund fees. Mackenzie Financial Corp., the largest fund company selling through independent brokers and dealers, is planning to introduce new classes of fund shares by this spring to give some wealthier investors a break. “It will be significant,” promises Phil Cunningham, president of Mackenzie’s main operating unit, which is still deciding how much it will cut fees. But Mackenzie, a trendsetter among companies selling through financial advisers, has no plans to reduce management fees across the board. Cunningham says Mackenzie’s MERs, which are much higher than no-load index funds, are justified because it costs more to hire money managers who make active decisions about which stocks and bonds are best to hold, and because part of the management fee is paid directly to financial advisers by Mackenzie. “A good adviser can put together a good portfolio that can certainly enhance your return, and importantly, keep you in that portfolio,” he says. Terence Buie, president of Dundee Mutual Funds, adds that the real question for customers to ask is: what are they getting for the money they are paying?
The load-fund firms find preaching the virtues of advice and service a safer course than trying to cut costs by reducing payouts to the people who sell their products. Raising commissions, on the other hand, is a strong incentive for new sales. A case in point: Sun Life-owned Spectrum United Mutual Funds Inc. jacked up commissions to six per cent from five per cent in January on most of its deferred-load funds. The move made frontpage headlines in the monthly trade newspaper Investment Executive.
There are limits to how much generosity brokers’ consumers are willing to tolerate. As awareness of fund fees grows, full-service fund advisers will face increasing competition from discounters, such as Scotia Discount Brokerage Inc., which on Jan. 15 became the first national distributor of funds to share with customers back-end commissions that fund companies pay to brokers at the time of sale. Scotia discount customers who invest at least $2,500 in a back-end-load mutual fund now get a 2.5-per-cent bonus, which amounts to half the commission normally received by brokers at the time of sale. “We think this program will help investors better understand how backend loads work,” says Scotia Discount Brokerage president and CEO Andrew Scipio del Campo, whose firm raised the bonus to three per cent for orders made over the Internet. Scotia’s discount brokerage was not the first to unveil the innovative commission kickbacks. That honour went to a tiny Torontobased dealer called The Fund Company Inc.
Scotia’s aggressive bid to grab market share prompted a defensive move by the
country’s largest discounter, Toronto Dominion Bank’s Green Line Investor Services. It matched Scotia’s price break— except for the Internet offer—and also lowered the eligible purchase amount to $1,000. “It’s a competitive marketplace out there,” says Green Line president John See. He predicts a trend towards lower mutual fund fees that are more visible to consumers. “We thought this was a good opportunity through which we could build our business,” he says. Other major discounters are following suit. So far, they include Royal Bank Action Direct, with a
2.75per-cent rebate on all deferred-load sales, and Bank of Montreal’s InvestorLine Discount Brokerage, which offers a bonus of 2.5 per cent on phone orders and three per cent on electronic orders. As of Feb.l, CIBC Investor’s Edge is offering a
2.75per-cent bonus on phone orders and three per cent for online transactions.
The commission rebates represent an escalation of the price competition in the discount brokerage sector, which has seen the development of one-stop shopping centres for multiple brands of funds at reduced costs. One of the pioneers is Canada Trust’s OneStop Fund Solutions discountbrokerage service, which offers third-party funds with no front-end or deferred sales charges. Fund companies pay fees to OneStop of up to one per cent of the fund’s assets, and the brokerage often collects the same point-of-sale commission as a full-service adviser. No-load direct seller Altamira has also been influenced by the trend and has acquired London, Ont.-based independent discount broker Mutual Fund Direct.
Another boost for the discount sector came in December with the entry into the market of U.S. discount giant Charles Schwab Corp. ‘When Schwab does something, it’s very closely watched,” says Cerulli consultant Andrew Guillette. “Often they can be a barometer of things to come.” Toronto-based Charles Schwab Canada now has only $185 million in client assets, but it hopes to grow rapidly by offering Internet-based trading, fast access to research and highly responsive client services. Though Schwab’s strategy is not to be the price leader, its president and CEO, Paul Bates, still thinks the overall trend for fund fees is down. “MERs,” says Bates, “will come under pressure and I believe there will be a lot of pressure brought to bear for the complete disclosure of trailers”—the annual commissions that brokers receive to ensure that their clients stay with a particular fund company. He predicts that clients will be inclined to ask for trailer-fee rebates if their advisers can’t justify their commissions. If so, that would mark a new militance from what until now been a passive breed of Canadian fund investor. □
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