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Will Actively Managed Mutual Funds Ever Go Away?

Nelson Smith — Thu, 02 Feb 2012 10:00:04 +0000

These days, the passive investing movement is gaining momentum faster than I get rejected for dates by attractive ladies. And for good reason. Actively managed mutual funds may sometimes outperform the index, but are more often than not surpassed by their passive brethren. Math would indicate that the average fund would match the overall stock market, since mutual funds are such large participants. And this is true, except for one little caveat: fund fees. The fees cover all sorts of things – like paying the advisor who sold the fund to the investor, as well as paying the fund manager and the fund’s expenses. The fees also include advertising to expand the mutual fund, as well as ensuring the mutual fund company makes a healthy profit.

It seems like every blog is touting the advantages of passive investing. And yet, millions of Canadians continue to invest in mutual funds that, thanks to fees, will continue to underperform the underlying index. Will passive investing ever make actively managed mutual funds go away? I don’t think so, and here’s why:

Marketing

Between Canada’s big 5 banks and our handful of actively managed mutual fund companies, billions of dollars are spent promoting their wealth management products. They’re clever at their advertising, never actually pushing their products directly, rather preaching a message of security. Financial security is only a few trips to the bank away, at least according to their advertising.

TD uses two old men primarily in their advertising, along with a big comfy green chair. Just go to TD, the commercials say, and you won’t have to worry about money. The old men seem pretty happy with TD’s offerings, after all, they do hang around outside of the bank.

I’m picking on TD specifically, but each bank in Canada is guilty of using the same marketing techniques. And why shouldn’t they? They don’t really care about how much investors in their products make. All they care about is driving results for their shareholders.

The Way They’re Sold

Let’s divide mutual fund salespeople into two groups, the people who work at banks and the people who work for separate wealth management companies like Investor’s Group.

Both groups are similar in the way they get compensated, which is a sales fee when the investor buys the fund, as well as a fee every year the investor holds the fund, called a trailer fee. Advisors are thus rewarded for getting more business.

In a bank, there isn’t much need for the mutual fund folks to go out and drum up new business. The bank places promotional materials around the branch, especially during RRSP season, urging investors to contribute to their investments. Bank tellers are also encouraged to upsell products to people with large chequing account balances, or people who just don’t have any investments with the bank. Bank mutual fund representatives have a whole branch funnelling prospects their way. So they don’t have to work that hard to sell.

Meanwhile, the independent salespeople do have to drum up business. They do the usual things to drum up business – networking, marketing and the like, all in the hopes of increasing their assets under management and their trailer fees. With several different companies offering very comparable products, it’s a dog eat dog world out there. They work hard to get the business the banks do not.

And then we have the world of exchange traded funds and index funds. The companies who manage them make money, but once a product is introduced that seeks to replicate a certain index, that’s it. You can only have one product per index. Since management fees on these products are minuscule, (hence making them best for investors) nobody has any financial interest to push them. Financially savvy people learn about them, while Joe Investor does not.

There’s a whole army of people selling actively managed mutual funds, and hardly anybody singing the praises of passive investing. This is starting to change, but it’s not going to be an easy fight.

A Lack Of Education

Fellas, if you ever want to ruin a date, start talking about investments. You might catch a woman who’s legitimately interested, but for the most part, the ladies don’t care about this stuff.

Okay, to be fair, I also know a fair share of guys who don’t give two hoots about investing either. People can’t be bothered to learn even the basics. The terminology is hard. The content is boring, and often too math-y for people. People just aren’t interested in learning about how to be better investors.

Then comes along the friendly mutual fund salesperson who caters nicely to this attitude. Don’t worry about anything, they say, just give your money to me and some smart investment type people will manage it. This appeals to somebody with little investing education, so they’re happy to oblige. Some might call it preying on the uninformed, but banks call it good business.

Until everybody becomes better educated financially, I don’t envision actively managed mutual funds with high fees to go away. What do you think?

Will Actively Managed Mutual Funds Ever Go Away? originally appeared on Canadian Finance Blog on February 2, 2012.

Paying Fees On Your Investments

Jim Yih — Tue, 04 May 2010 09:00:09 +0000

Most recently, I wrote an article highlighting some of my research showing that mutual fund fees do matter in investing. Mutual fund fees are only one type of fee that impact investors returns. In this article I would like to highlight some of the different types of fees that every investor should be aware of.

Mutual Fund Fees

When buying mutual funds, there are three key types of fees to be aware of:

1. Management Expense Ratios (MER) – Lot has been written on management expense ratios. They are one of the primary fees to be aware of when investing in a mutual fund. The Management Expense Ratio measures all of the fees and expenses associated with the fund. One of the expenses wrapped into the MER is the ‘trailer fee’ that goes to the financial advisor or broker as part of their ingoing compensation.

2. Front End Load – In Canada, front-end loads are completely negotiable. In many cases you can pay as little as nothing to as high as 5%. This fee comes right off your investment. For example, if you are investing $10,000 and you pay a front-end fee of 2%, you will pay $200 for the purchase and $9800 will get invested. Paying a front-end fee means you have less money at work.

3. Back End Load or Deferred Sales Charge – A back end load is different in that you do not have to pay anything up front. In the same example, you will have $10,000 invested and put to work. However, the mutual fund company has hooked you into a 6, 7 or 8 year time frame where if you leave their company before a certain time, you will have to pay a penalty for leaving early. The longer you stay with the fund company, the smaller the fee. Typically, you can still move your funds around within the same company without triggering fees. The theory is that back end loads promote long-term thinking.

A significant part of the front and/or back end loads go to the financial advisor or broker for compensation. Do it yourself investors also need to be careful. I’ve seen some investors who have bought mutual funds in their discount brokerage accounts choose the wrong versions of a mutual fund, where they buy a back end load fund instead of choosing the no load option or the front end load option.

Other Fees

Discretionary Fees – On some larger investment portfolios, financial advisors or brokers will promote the merits of a discretionary account. This annual fee is similar to a MER but it is negotiable depending on account size. This fee can also be potentially tax deductible on non-RRSP accounts. The investment industry is a scalable industry which means the more money you have to invest, the more you can negotiate the fees. Discretionary fees typically range between 1% and 1.5%. The big thing to be careful of is to watch the fees on the investments in the account. If you hold a mutual fund inside a discretionary account, you will be paying 2 sets of fees. Especially watch for double dipping where the broker is making money from the discretionary fee as well as the fees off the underlying investments inside the portfolio.

Self-Directed Fee – This fee only applies to RRSPs and is typically charged by the administrating financial institution. Self-Directed RRSPs allow investors to invest in a myriad of investments not restricted by the investments offered by one single company.

Trading Fees – Trading fees refer to the cost to buy and sell specific investments and/or securities within an investment account. Typically full service brokers will charge higher trading fees than discount brokers. If you are paying discretionary fees, you should not be paying trading costs. Watch how your trading fees affect smaller purchases. For example paying a $50 fee to buy a $1000 worth of stock is really a 5% fee. It might be more economical to buy no load mutual funds on smaller purchases.

There can be other fees like account closing fees, administrative fees, withdrawal fees, etc. Fees will differ from institution to institution so it is important that investors be aware! Know how much you are paying in fees. Never be afraid to ask what the fees are and how institutions and advisors get paid.

Paying Fees On Your Investments originally appeared on Canadian Finance Blog on May 4, 2010.

Would You Invest In The O’Leary Funds?

Guest — Tue, 09 Feb 2010 10:00:56 +0000

Whether you’ve seen him on various television shows such as BNN’s SqueezePlay, or as a ‘dragon’ on the CBC’s Dragons’ Den, Kevin O’Leary is truly a colorful character. With his recent move from BNN to the CBC’s The Lang & O’Leary Exchange, along with his appearances on ABC’s Shark Tank, chances are, you have seen this cat on the tube. One thing is for certain – this guy is one busy man.

But have you heard of his funds? And could they offer sound investment opportunities to for you and your hard earned dollars? The Canadian billionaire who made his fortune in the consumer software industry is never shy in expressing his thoughts or pursuing new ventures. After selling his company back in 1999 to the Mattel Toy Company “for a staggering 3.7 billion dollars”, he decided to go on and form his own mutual fund company, O’Leary funds.

The company’s site will tell you that “O’Leary Funds was formed by Stanton Asset Management CEO Connor O’Brien, and top-rated television host Kevin O’Leary to provide investors with deep value, tangible yield and unique global investment opportunities.”

Let’s take a closer look at the types of funds that are currently being offered to the investor and then compare some of the pros and cons associated with investing in any of the O’Leary Funds.

In terms of the closed-end funds, here is the list of funds available:

O’Leary Global Equity Income Fund (OGE.UN)
O’Leary Global Infrastructure Fund (OGN.UN)
O’Leary Global Income Opportunities Fund (OGO.UN)
O’Leary Global Canadian Income Opportunities Fund (OCY.UN)
O’Leary Founder’s Series Income & Growth Fund (OFS.UN)
O’Leary Canadian Equity Income Fund (OCZ.UN)
O’Leary BRIC-Plus Income & Growth Fund [IPO on Jan 26, 2010 (NEW)]

Regarding mutual funds offered to investors, the company offers its new O’Leary Strategic Yield Class fund (Class Series A, F, F6, and T6).

From my perspective, I believe that some of the pros in relation to some of these funds are that many of them offer global diversification “by region and by sector”, and their investment funds are primarily allocated in “dividend-paying common shares, preferred shares, and bonds of public issuers, with each issuer generally having a market capitalization of $1 billion or more”.

Equally importantly, if we check out some of the current yields of some of the funds we find that most of the closed-end funds offer above-average respectable yields between 6%-8% with distributions paid out monthly. Having shares can allow for the investor to have an income stream while waiting for long-term capital appreciation, unlike many other funds in the industry.

Now comes the cons, and in my view, they cannot be overlooked. Despite some of the positive elements to some of O’Leary’s funds, on the flip side, unfortunately, we know there are MERs (management fees) associated with purchasing funds.

After navigating the company website for a considerable period of time in search of the funds’ associated MERs, I came to the conclusion that I would have to first seek elsewhere as the site was not as open and transparent as I hoped it would be. My gut was telling me that there was ‘more than meets the eye’.

It turns out that the MERs appeared to be relatively high indeed. A spring 2009 post by Wellington Financial states that the MER for OGE.UN as an example was “at 3.52%…a far cry from the ‘low’ 1.5% level that Mr. O’Leary promised last summer”.

A fairly recent thread at Four Pillars by Mike titled, “Questrade Mutual Fund Fee Rebate and Free Transfer Offer” engaged a sizeable audience, and one of the commentators (Josh Thurston) on the post mentions how O’Leary created a hidden “vampire fee” by supposedly originally stating that the OGE management fee would be only 1.5%, but because of the 0.4% trailer mentioned in the fund’s prospectus, the management fee is now 1.9%.

After reading this, I immediately went to investigate further and finally opened up the O’Leary Global Equity Income Financial Statements, June 30, 2009. In it, on page 14, I was able to confirm the above-mentioned comment after reading the following:

“…the Manager is entitled to an annual management fee of 1.5% of the net asset value of the Fund at month-end, plus an amount equal to the service fees, paid monthly in arrears, plus applicable taxes. The Portfolio Manager will be remunerated by the Manager out of the management fee. Savtrev will be remunerated by the Portfolio Manager. The Manager will pay registered dealers a servicing fee equal to 0.4% annually of the net asset value per unit for each unit held by clients of the registered dealers, plus applicable taxes.”

After investigating some of the other funds, they too had the 1.5% + 0.4% servicing fee for a total of 1.9%. Depending on your level of comfort, this may be a positive or negative aspect to your own personal strategy.

Personally, my investment strategy no longer entails me owning funds in general. Despite the fairly lucrative yields that the O’Leary funds offer, coupled with an impressive basket of equities he and his team have concentrated on for global diversification and capital appreciation purposes, I just cannot get over the management fee component.

My position is that I would rather invest directly into equities and other investment vehicles, which do not entail buying funds. What about you? Would you invest in any of the O’Leary funds? Do you already own some of them?

This is a guest post by The Rat from Ending The Rat Race. If you liked this post, please consider subscribing to his RSS feed.

Would You Invest In The O’Leary Funds? originally appeared on Canadian Finance Blog on February 9, 2010.

Dividend Funds That Don’t Pay Dividends

Tom Drake — Tue, 18 Aug 2009 09:00:07 +0000

There are many great dividend stocks in Canada. I personally have about 30 that I’m watching for when I begin my Smith Manoeuvre. However, if you’re looking to mutual funds to fill the Canadian dividend portion of your portfolio, you may not be getting what you pay for.

First off, since these funds have Management Expense Ratios (MERs) in the 1.6-1.7% range, this creates quite a drag on the dividend income you can expect from this type of fund. To compensate for this, fund managers have to look elsewhere to bring the payout back up.

Four of the five major Canadian Banks have Canadian Dividend funds that are made up of only about 85% Canadian equities. TD bank was the only exception, being in the 95% range. The rest of these funds include T-bills, as well as US and international equities. Even within the Canadian equities portion, not all stocks are dividend paying equities and other stocks have low or unstable dividend payments.

This creates a few issues. You are not getting only the dividend paying equities that you were looking to add to your portfolio, you are likely just adding another high-MER equity fund with a different name. This fund will also not provide the tax efficiency of a true dividend only fund, since the payouts include capital gains and return of capital (ROC).

So what are your options for adding dividend paying companies to your portfolio? With mutual funds, not much, though the TD Dividend Growth funds may be closer to the real thing. Your best option might be Exchange Traded Funds (ETFs). Two great choices are the iShares CDN Dividend Index Fund (XDV) or the Claymore S&P/TSX Canadian Dividend ETF (CDZ). While you would have to pay commissions to buy these ETFs, the 0.5-0.6% MER and the fact that you get the dividend paying stocks that you’re looking for will make it worthwhile.

Dividend Funds That Don’t Pay Dividends originally appeared on Canadian Finance Blog on August 18, 2009.

How To Setup and Rebalance TD e-Series Funds

Tom Drake — Thu, 26 Mar 2009 10:00:23 +0000

There is a bit of effort you need to put in to invest in TD e-Series Funds, but it is worth it. First of all, you need to apply using the pdf available on the TD Canada Trust website.

The Account Application is pretty straightforward. You’ll need to provide information like your name, SIN, date of birth, and banking information.

The next couple pages are the Wealth Allocation Model and then the Investor Profile. Fill out the Wealth Allocation Model to provide your Total Point Score. This score will show you which asset mix would be right for you. TD will review this and want the asset allocation to match your score. Because of this, if you are quite sure of what allocation you want, you may want to adjust your score to match that.

The Portfolio Worksheet is where you enter the exact asset mix you want and the amount you are investing, both as a lump sum and pre-authorized purchase plan. To keep it really simple, many investors with a long enough investment time frame might benefit from a equal split into:

Fixed Income 25% – TD Canadian Bond Index
Canadian Equity 25% – TD Canadian Index
U.S. Equity 25% – TD U.S. Index
International Equity 25% – TD International Index

Next is a simple Understanding & Consent form to sign. In the Transaction Form you have to re-enter the information from the Portfolio Worksheet. These two asset mixes do need to match.

Then mail it in to TD e-Series Funds Administration. The full address is on the first page of the pdf. Once everything is setup, TD will mail you your login information.

Once a year, you should rebalance your portfolio back to your original asset mix. Using my example above, if you have a certain amount available to invest, put it into the under performing funds to bring them back up to 25%. If you do not have enough new money to re-balance, you can sell some of the better performing funds and put it back into the others. By rebalancing, it forces you to buy low and sell high.

These steps will provide a diversified portfolio, investing in the entire index that the funds track. You can rebalance it yourself and you will be paying a Management Expense Ratio (MER) of less than 0.5%.

How To Setup and Rebalance TD e-Series Funds originally appeared on Canadian Finance Blog on March 26, 2009.

TD e-Series Funds

Tom Drake — Wed, 25 Mar 2009 10:00:17 +0000

TD e-Series Funds may be the simplest way for someone to invest in a diversified portfolio with low Management Expense Ratios (MERs). Below are the four funds that you can use to build a rather complete portfolio and would work well for regular contributions into an RRSP or RESP.

TD Canadian Bond Index tracks the performance of the DEX Universe Bond Index. The Universe Index is comprised of Canadian investment-grade bonds which mature in more than one year. It has a MER of 0.48%.

TD Canadian Index tracks the performance of the S&P/TSX Composite Total Return Index. The S&P/TSX Composite Index is comprised of Canadian issuers traded on the Toronto Stock Exchange. It has a MER of 0.31%.

TD U.S. Index tracks the performance of The Standard & Poor’s 500 Total Return Index. The S&P 500 Index is comprised of 500 widely-held U.S. issuers. It has a MER of 0.33%.

TD International Index tracks the Morgan Stanley Capital International Europe, Australasia and Far East Index. The MSCI EAFE Index is a broadly diversified index consisting of equity securities of companies domiciled in developed markets outside the U.S. and Canada. It has a MER of 0.44%.

Not only do these four funds invest you in the entire index, their MERs are about 2% lower than the average mutual fund. This 2% advantage can go along way when investing over a long term.

Tomorrow’s post will detail some of the advantages that the TD e-Series Funds have over other mutual funds and show you how to open this type of account.

TD e-Series Funds originally appeared on Canadian Finance Blog on March 25, 2009.