Column

Calculating the costs

Ross Laver February 2 1998
Column

Calculating the costs

Ross Laver February 2 1998

Calculating the costs

Personal Business

Ross Laver

Suppose you owned a business that rang up millions of dollars in profit every year, yet most of your customers were not even remotely aware of how much they were paying for your service. You’d consider yourself pretty lucky, right?

Now you know what it’s like to run a mutual fund company.

That’s no joke. In a survey last year, the Toronto-based consulting firm Marketing Solutions found that 63 per cent of fund buyers were unaware that they were being charged an annual management fee.

Who is to blame for this appalling state of ignorance? Much of the responsibility surely lies with investors. In an ideal world, no-one would ever dream of putting money into a mutual fund without reading the prospectus, which spells out the fund’s investment style and the annual management fee—usually between one and 2.5 per cent. (The standard knock against these documents is that they are too complex to be understood by the average person, but that excuse holds less water now that most of the big banks and fund companies have introduced simplified prospectuses.)

That said, the fund industry still has a lot to answer for with respect to the way it reports fees and expenses. Particularly in RRSP season—which this year runs until March 2—fund companies love to crow about the returns racked up over the past few years by their most successful funds. Wouldn’t it be wonderful if industry representatives got together and agreed that every such ad should also state the fund’s management expense ratio—the total percentage of assets that goes to management fees, legal and accounting charges and other expenses?

Alas, that’s not likely to happen soon. In fact, there are not even any rules governing how fund companies calculate the MERs that are published in the financial press and distributed to investors through independent rating services. “In my mind, the MER is the worst number in the business,” says

The fund industry still has a lot to answer for with respect to the way it reports fees and expenses

Rob Bell, president of BellCharts Inc., the company that prepared rankings for last week’s Maclean’s report on the best and worst mutual funds.

In some cases, Bell says, the MER is based on the fund’s expenses over the most recent 12 months. But at other times, it is an annualized figured that reflects only those expenses that were reported in the most recent calendar quarter. Coming up to RRSP season, a fund company can make its MERs seem lower than they are by failing to report legal or advertising expenses until later in the year. “It would be much better if there were industry standards, but at the moment we can only report what the fund companies tell us,” Bell says.

Another problem stems from the increasing popularity of so-called wrap accounts for investors with large portfolios. Typically, members of these programs pay a sliding annual fee based on the size of their portfolios. The account is then divided among a range of funds, each carrying its own expense charge.

The two-tier fee structure of a wrap account has significant tax benefits, but it also makes it difficult to judge how those funds are performing relative to their competitors. For example, Top Funds ’98, a best-selling book by Riley Moynes and Michael Nairne, includes among its selections two funds sold under the Optima Strategy brand, both with MERs in the 0.4-percent range. The book does not mention that Optima funds are available only to clients who pay a yearly wrap fee of as much as 2.5 per cent of their assets. And there is only one brief reference in the acknowledgements to the fact that the company behind Optima, Loring Ward Investment Counsel, is a sister firm of The Equion Group, for which Nairne and Moynes both work.

In an interview last week, Nairne blamed an editor’s error for the fact that Top Funds understates the management expenses associated with Optima funds. Be that as it may, the case illustrates the need for tougher regulations and more complete disclosure by the mutual fund industry.