Mackenzie’s Fund Report Misses the Point

Ah, the good people at Mackenzie Financial. Last year, they brought us I Thought I Wanted an ETF, a marketing brochure full of red herrings and half-truths about exchange-traded funds, clearly designed to discourage their clients from getting out of Mackenzie’s high-priced dreck and into low-cost investments. You can read discussions of this little gem on Larry MacDonald’s and Jon Chevreau’s blogs.

Now the consumer advocates at Mackenzie have released a new report called Canadian Mutual Fund Ownership Costs: Competitive Relative to the U.S. It looks to bust the popular idea that US investors pay dramatically lower fund fees than Canadians. You can download either the six-page research summary or the complete 14-page report. If you have a pronounced gag reflex, I suggest the briefer version.

Fees are calculated differently

I’ll concede that several points highlighted in the report are true, and that they’re often misunderstood by investors and the media, who tend to focus on Canada’s undeniably higher MERs. “The calculation of mutual fund expenses is different between the two countries,” the report rightly argues, noting the following:

• Non-negotiable front-end loads up to 5.75% are common in the U.S., but are now rare in Canada, where deferred sales charges are much more usual. Buy-and-hold investors may be better off with DSCs than front loads.
• U.S. investors pay between 0.25% and 1% in 12b-1 fees, which go toward marketing and promotion of the funds. Canadian funds have no such fee.
• The MER of Class A mutual funds in Canada includes a 1% trailer fee for the advisor’s services. US mutual funds do not compensate advisors with this type of embedded fee.
• U.S. investors don’t pay GST or HST on management fees, which can easily add 25+ basis points to the MER of Canadian mutual funds, something we can’t blame fund companies for.

The above factors mean you can’t simply look at the lower MERs on U.S. funds and jump to conclusions: “After controlling for these differences, the Canadian pre-tax [cost of ownership] of mutual funds is very similar to that of the U.S. for the large majority of Canadian investors.”

US funds are just as bad — except for all the good ones

Unfortunately, the Mackenzie report focuses only on actively managed funds sold through commissioned advisors. That sidesteps the real issue: the reason that Canadian fund investors look to the US with envy is not because their commission-based advisors are better than ours. It’s because Americans have so many excellent alternatives to that model.

The big boys in US fund industry are Vanguard and Fidelity, both of whom allow investors to bypass the toll-taking advisor and invest in their funds directly. These companies offer an extraordinary menu of index funds with fees as low as 0.10%. Tens of millions of Americans invest like this: direct-sold funds make up 30% of the US market. They are all ignored in the Mackenzie report.

Canadians can invest directly through low-cost companies such as Philips Hager & North, Mawer, Steadyhand and McLean Budden, though direct-sold funds make up a mere 8% of fund assets in this country, according to the report. And none of these firms offers index funds. If you’re a Couch Potato investor, your only choices for direct-sold index funds are the ING Direct Streetwise Funds or the TD e-Series Funds. Even these are far more limited and expensive than what US investors have access to.

Canadians who buy mutual funds through discount brokerages get gouged, too. Our banks’ index funds charge at least three times what US index investors pay. And DIY investors who buy Class A funds still pay that 1% trailer fee for nothing: discount brokerages pocket the “advice” fee despite giving no advice. (Questrade is the only brokerage with the decency to rebate these fees, albeit with some conditions.) This cash grab is not practiced in the US, and indeed, the Schwab, Fidelity, and Vanguard brokerage arms even allow clients to buy ETFs with no commissions. No such luck here.

Mackenzie argues that pitting Vanguard and Fidelity against Canadian mutual fund offerings is comparing apples to oranges, but that’s the whole point. We don’t have any oranges. All the report proves is that crap in the US smells as bad as crap in Canada.

But I’ve saved the best for last. Here are the specific findings from the report, showing the average annual cost of ownership of advisor-sold mutual funds in Canada:

• Canadian equity: 2.38%
• International equity: 2.51%
• Balanced funds: 2.34%
• Fixed income: 1.66%

Remember, Mackenzie is presenting this as good news. And if you’re a fund manager or fund salesperson, I’m sure it is.