from the Fund Library

Hello Judy,

The answer is: not in Canada. Because the consumer is not sophisticated enough here. -investor-

Try Saxon, Mawer and Scudder (Scudder has a small trailer, but still the MER is low).

THIS IS NOT A RECOMMENDATION TO PURCHASE AN INVESTMENT PRODUCT - AN INTERESTED INVESTOR SHOULD ALWAYS CONSULT HIS OR HER ADVISOR TO CONFIRM THE APPROPRIATENESS OF ANY INVESTMENT PRODUCT FOR THE PORTFOLIO.

Warren.

WARREN,

IF YOU MUST (MUST!) PRINT THE DISCLAIMER, HOW ABOUT DOING IT THE POLITE (POLITE!) WAY ON THE WEB. In small letters.

PS (Did you know that ALL CAPS are actually harder to read, a reason why some US States are going to having their road signs in all small letters. And also the reason that Re/Max had originally had of their agents names in small letters - with no capitalization)

Low MER's; no trailers -

Holy Grail in Canada - Just add low minimum contributions.

Take a peek
t'is a cryin' shame
but don't we-all
share the blame?

Inspired by a recent FP article by Jonathan Chevreau.

Gummy, one picture is really worth a thousand words! Your chart explains why the stocks of Financial Companies are doing a great deal better than the Funds they administer. The question is: Why are we still investing in Funds when we could all participate in the fleecing of the unwashed by direcly buying the stocks of these Companies?

Bravo again gummy!!!

Very impressive gummy, but I'm not sure I understand it. Does the portfolio in the graph have a 0% growth?

Gilles,

That is exactly what I was going to point out. This (from what I understand) is based on the ORIGINAL portfolio amount, not what it's grown to.

The calculator in the item I cited above lets you plug in values for initial investment, monthly DCA, annual growth, inflation, MER, taxes, etc. Now if only it could plot a nice chart...

Rob,

It cannot be based on the original portfolio amount since (1.03)²⁵ - 1 is 109.4 percent, and according to the 3 percent curve the percentage consumed is just under 55 percent.

The correct approach for a fund with a 25 yr return of 10 percent and a 3 percent mer would be

$1 x (1.13)²⁵ = $21.2305

$1 x (1.10)²⁵ = $10.8347

21.2305 - 10.8347 = $10.3958

So a 3 percent MER shaves off $10.3958 off of the original $21.2305. Therefore the percentage "consumed" by the MER is 10.3958/21.2305 or 49.0 percent. This still doesn't correspond to Gumby's graph, though.

Gumby?

If the underlying stock increases, each year, by factors
G₁, G₂, ... G₂₅
then the "potential" value of a $1.00 portfolio (after 25 years) is the product:
G₁G₂...G₂₅.
Each year the MER shaves of a fraction I (for MER=3%, I = .03), leaving (1-I) in your portfolio.
The actual portfolio value (after 25 years and 25 MER reductions) is then
G₁G₂...G₂₅(1-I)²⁵.
It's the factor (1-I)²⁵ which reduces the "potential" value of your $1.00 portfolio.
By how much is it reduced?
By 1 - (1-I)²⁵ and, for I = .03, that's
1 - .97²⁵ = .533 or 53.3%
Ain't that right?
(If not, I'll deny everything!)

jd: If the stock increases to $1x(1.13) and
there's a 3% MER reduction, that leaves
$1x(1.13)(.97) ... which ain't $1.10 (as you imply).
Indeed (to use your numbers) you should get:
(1.13)²⁵ - {(1.13)(.97)}²⁵
so the reduction is by a factor
(1 - .97²⁵), no?

Gilles, Rob: Suppose the final value of your portfolio (after 25 years and NO MER reductions) would have been $100,000. Then, because of a 3% MER reduction each year, the fund company gets to keep $53,303 (53.3%) and you get the rest ($46,697) ... uh, well, Paul Martin gets 1/2, so you get to keep, uh, $23,349 (if yer in a 50% tax bracket) and ... uh, yer wife gits ... uh ...

Gumby,

Yes.

Very general and elegant. As usual I simplified too much.

Gummy, great graph .... well done!!

RC, yeah, sorry for the shouting, perhaps next time I'll try to put the emphasis in a different format, eh.

Warren.

Thanks Warren ... But how about no (NO) no emphasis? Is the emphasis really going to help your claim in court?

The other side to this view is "are you getting value for your money?" This is entirely different discussion but relevant to the question.

Given the huge amounts of regulation, disclosure requirements and choices, perhaps the MER is appropriate. If it were not, shouldn't the market take care of itself and MER's reduce? Perhaps as the fund companies gain greater economies of scale with larger asset bases we will see this.

Also, a portion of the MER is the commission as has been pointed out. I don't know about you guys but I don't mind paying my FA in this way particularly if 100% of my capital is invested.

All comes back to value, does it not? If you don't like the MER's, perhaps you are not getting good advice from your FA?

Any other thoughts?

Aren't you an FA, Doug? Just checking, I thought I read something earlier today where you mentioned that.

Gummy:

I think your Y-axis should be % of original investment - portfolio value. I believe that's what Chevreau wrote about. I don't have time right now to check your numbers above, but it sure seems high that a 2% MER would eat 40% of your portfolio. I think it makes sense if you relate it to a lump sum purchase over so many years, that the annual MER would add up to a high percentage of your original investment. What was your annual rate of return assumption? I think it's more relevant to express MERs in terms of % of net return. % of original capital ignores the growth that goes along with the MER.

Here's are other ways to look at the effect MERs on our investments.

This one shows the effect of MERs on a $1,000 investment earning 10% over 25 years:

With a 0% MER your investment will grow to $10,835. With a 3% MER, the investment will grow to $5,060. A difference of 40%.

The following graphs shows the effect of MERs when DCAing $1,000/year for 25 years with an annual return of 10%:

With a 0% MER your investment will grow to $109,182. With a 3% MER, the investment will grow to $65,605. A difference of 53%.

gummy: thanks for fixing my spreadsheets and for storing them on your site.

Oops, change that 53% to a 40%.

and change that 40% to a 53%. Confused now? good... I'm not alone. :)

Ontario FA: Yes, I am a FA sorry if this wasn't clear. My point was about value.

Point being: Given my asset base, I can set up a client on 0% FE load and earn a decent living from trailer commissions. Result: client gets the advice for free and can leave any time. Not a bad deal.

Gummy & Gilles: WRT MER's I don't think it is relevant to consider a 0% MER or any MER less than 1.5% for that matter (assuming stock funds). Assuming this is how the fund managers get paid, etc. then the appropriate consideration is the savings from a typical 2.5% to a better 1.5% MER. Of course, I am also assuming that there is some benefit from some professional management in mutual funds. If you were to use a full service broker and turn your portfolio over even 20% per year, you could be looking at similar investment costs (ie: 2.5% of portfolio value per year).

Thus, by investing in funds we could be benefiting from great management (knock on wood) and if we were to save 1% on the MER then our actual savings in your example would be approximately $20,000 over 24 years (ie: I took the value of the 0% MER and found the dollar difference with the 1% MER). Certainly this is a reasonably large dollar amount, but not quite the large 40% difference noted above.

Just a thought.

Doug, sorry I disagree with your comment about not considering MER's on equity funds below the level of 1.5%. Currently, I can think of several funds that we use in the Bissett, PH&N, Mawer and TDGL families that run at significant basis points below 1.5%.

OK, OK, that's us, but it's a given that MERs on Cdn funds are too high - my point is that the more there are discussions like this the more likely we are to see a better deal for investors. Good heavens, man, MERs in the range of 2.5% and even over 3% to run a simple pool of Cdn equities, what's the justification?

Warren.

"The time has come,"
the Walrus said,
"to speak of many things.
Of MERs in Mutual Funds
... as well as cabbages and kings."

Just a suggestion, if you are irritated by high mer, why don't you open an account at TD greenline or BMO investor and buy TIPS and HIP. If you do pay close attention, you'll discover that less than half the mutual funds beat those averages. And remember, your MF are managed money, not the TIPS or HIP, so why do you waste MER on overall lower performance?

I'm not convinced that TIPS or HIPS is the way to go. It certainly isn't value investing, it's more like momentum investing. Check out the article in TIPS and HIPS on Madelyn's Web site.

And even if I was to use TIPS or HIPS, they wouldn't take up more than 10% to 15% of my portfolio. What would I do for the other 85% to 90%?

Doug, you have a good point. Probably a MER of 1 to 1.5% is good value considering the fact that investing on your own would have some transaction fees and the fact that your own portfolio would probably not perform as well as a professionaly managed fund.

This is an excellent thread. I'd thought I'd resurface this just in time for the end of this RRSP buying season.

Two points in response to Gilles last post:

1) Re. this 'momentum investing' theory - I don't know what Madelyn argues on her website, but if she's arguing that it's the mass influx of cash to index funds themselves that drives much of the gain of the Index (ie, loads of money into index-type products based on an 'index mania' makes the heady returns of the Index a self-fulfilling prophecy based on an investor frenzy to purchase such products), I don't think such an argument holds any water.

For a very brief, well-written counter-argument to such a notion, take a look at the 'Plain Talk: Five Myths About Indexing' piece on the Vanguard website in the "Investor Education, Library" section (www.vanguard.com). Myth #4 is entitiled 'The Success of Indexing is a Self-Fulfilling Prophecy', and it very eloquently explains why such a hypothesis is wrong. Indexing is FAR more popular in the US than it is in Canada (especially re. the S&P 500), so one would expect that if the success of TIPs and HIPs were largely the result of 'momentum' investing, the phenomenon must be 10 times as severe in the US. Not so....

2) There is more choice in indexing than just TIPs and HIPs. Canadians have access to SPDRs (S&P 500), Mid-Cap SPDRs (S&P 400), DIAmonds (DJIA30), MSCI-EAFE funds from TD and CIBC, Bond Index funds, low MER money market funds...I believe one could create a well-diversified portfolio (either inside or outside and RRSP) by simply using low-MER index products and Money Market funds.

Flyer,

Methinks that next time before you spend all that time crafting a well-thought out response, perhaps you should read the article. That's not at all what she's referring to.

Hi Rob - I did read Madelyn's article and her criticism is essentially predicated on the notion that the market is inefficient. She states that certain TSE 35 stocks have run up in value to an extent that buying them is riskier (she doesn't really say it in this way but's it is implyed). So what's riskier, these stocks that have gone up in value because of good fundementals or those stocks that are languishing with a low P/E because of poor company performance? Academics have taken to calling these "Value Stocks" distressed stocks instead just to make the point.

Regarding market efficiency (or inefficiency) we could debate that point ad nauseam. I'm open to opinion on this matter re smaller cap stocks, but we are talking TSE 35 companies -- the largest companies in CAnada. I find it hard to believe that the mass of relatively bright analysts looking at these 35 stocks could dramatically missprice these shares given the publically available info. And anyways, even if they are not that bright, maybe their "mistakes" on the up and downside cancel each other out.

PK,

What she's saying is that because of the run-up, it, in effect, makes it a "momentum" play. I can't remember alot, it's been along time since I read the article. (Maybe I should follow the link for a re-fresher, eh?)

Man! I'm damn confused now! What's with all these calculations and things! Can someone basically tell me what difference it really makes on which MER we pay. What is considered too high and what is considered low. Is there really such a thing a 0% MER and if so, how are these funds performing?? Also, do trailer fees really affect us?? How?? Please respond to this ASAP, thanks!

BTW, how do you post links within this document??

Damn Confused- you sure are. Do a search on previous 90 days threads and you'll find answers to all your questions and a lot more.

But remember, you must be 18 or older ;-)

For comparing two different mutual funds it is more useful to have some way of evaluating the effect their MER's will have on the return of the fund over a certain time period. Using my trusty spreadsheets I have calculated that a difference of 0.1% on the MER of two funds (for example 2.3% and 2.2%) The fund with the MER of 2.2% would outperform the MER 2.3% fund by approximately 0.47% over 10 years, 1.1% over 20 years and 1.85% over 30 years. This assumes the funds generate the same rate of return before the MER. The performance numbers are differences in value of the same investment made in each fund over the same time period

For a larger MER differential (say 2.0% versus 2.5%) the lower MER fund will outperform the higher one by approx. 2.35% over 10 years, 5.5% over 20 years and 9.00% over 30 years. The exact numbers vary slightly with the return per year generated by the fund

Well, using Gummy's ideas from a previous post, my Pentium (R) flawless CPU tells me:

@ 2.2% MER, 10yr, you get 80.055% of potential return;

@ 2.3% MER, 10yr, you get 79.24% of potential return

Ratio of case 2 / case 1 = 98.98%

which does not match in any case 0.47%

@ 2.0% MER, 30 yr, you get 54.548% of potential return

@ 2.5% MER, 30 yr, you get 46.788% of potential return

Ratio of case 4 / case 3 = 85.77% which again is a bit far from 9%.

As Gummy has shown, this figures are independent of the actual pre-MER return.

What is all this hoopla about MER's and trailers? Isn't the bottom line the investors real return? I would definitely agree that MER's are a factor but isn't one of the most important factor my return as an investor? I would suggest looking at software that ranks performance after MER's such as Paltrak or Hysales. Look at the two top performing funds over the last five years and guess what they have MER's of 2.52% and 2.45% but have returned to the investor 39.4% per year and 38.9% per year (after MER's). Or would you prefer indexed funds with low MER's of 1.1% and 1.28% that have returned 17.7% and 16.9% per year. I know where my money is. I would be very content to pay a 10% MER if the manager can return me a better return then a manager with a 1% MER. I would gladly pay for performance such as Warren Buffett who has vastly outperformed any indexed funds in the U.S. (even those with very low MER's). It's bottom line return based on risk tolerance that counts.

Sil

I forgot to include that my data was based on an initial investment of $1000 and a further investment of $1000 per year.

For a single $1000 investment I calculate a 0.1% MER difference to reduce the gain by 2.16%, a 0.5% MER difference to reduce the gain by 10.37% and a 1.0% MER difference to reduce the gain by 19.68%.

This is based on an investment that earns 10% per year on an annual basis over 25 years

bottom line,

Could you have predicted 5 years ago which specific funds would have the highest 5-year returns today? Can you predict which specific funds will have the best returns going forward 5 years?

Or as Gordon Powers said in the weekend Globe & Mail:

Q: Do no-load funds actually outperform load funds?

Definitely. But again this doesn't have much to do with actual portfolio performance results. It's all about costs.

On average, marketing and distribution costs add close to one percentage point each year to the management expense ratios of load funds when compared with their competition. And that makes a big difference. So much so that load funds, as a group, consistently underperform no-loads, according to a recent study by Toronto-based research firm Investor Economics.

Studying Canadian equity funds over a variety of periods ending in June, 1997, they concluded that while most funds -- regardless of how they're sold -- fail to beat the TSE-300 index, load funds were twice as likely to fall short when matched against no-loads distributed by direct sellers. The differential was considerably smaller when comparing load funds against those sold by banks and other deposit takers, though.

bottom line,

Could you have predicted 5 years ago which specific funds would have the highest 5-year returns today? Can you predict which specific funds will have the best returns going forward 5 years?

Or as Gordon Powers said in the weekend Globe & Mail:

Q: Do no-load funds actually outperform load funds?

Definitely. But again this doesn't have much to do with actual portfolio performance results. It's all about costs.

On average, marketing and distribution costs add close to one percentage point each year to the management expense ratios of load funds when compared with their competition. And that makes a big difference. So much so that load funds, as a group, consistently underperform no-loads, according to a recent study by Toronto-based research firm Investor Economics.

Studying Canadian equity funds over a variety of periods ending in June, 1997, they concluded that while most funds -- regardless of how they're sold -- fail to beat the TSE-300 index , load funds were twice as likely to fall short when matched against no-loads distributed by direct sellers. The differential was considerably smaller when comparing load funds against those sold by banks and other deposit takers, though.

Bylo,

What is your approach regarding index funds, do you buy them? for what market? When do you use index vs no-load vs load (at 0% FE I presume)?

Just curious.

Gilles,

I don't buy index funds. I just preach about them. (Just kidding!)

For the TSE I use TIPs and HIPs. For a pure S&P 500 play, SPYs are probably best for a Canadian investor. I'm into somewhat more esoteric index funds like the value part of the S&P 500 (VIVAX) and the Wilshire 5000 (VTSMX) so I use Vanguard via Waterhouse in the US. (Also bought a small amount of BRK.B to tap into Warren Buffet.)

Haven't bought any foreign index funds yet. CIBC's EAFE fund looks interesting (MER 0.9%) but they still haven't responded to my request for a prospectus and answered some specific questions that I asked them.

Not much available in bond index funds (at least not with a decent MER) so I use PH&N Bond fund. It's MER is 0.57% and has closely tracked the SCM Universe Bond index (mid-term bonds) for years. CIBC's new bond fund is the lowest cost bond index fund (MER=0.9%)

I'm relatively new to indexing so most of my portfolio is still actively-managed. New money is going into index funds. My objective is to have around 1/3 to 1/2 of my assets in index funds. I expect it will take some years to get to that mix. BTW, all my index funds are non-RRSP where their tax efficiency can be put to best use.

For managed equity funds I use a variety of PH&N Canadian Equity, Dividend, Balanced and US Equity funds. I'm also looking at Bissett for small cap and balanced.

Outside North America I'm evenly split between Trimark Fund and Templeton Growth. I also have a smattering of SU American Growth, CI Pacific, GBC Canada and GBC NA from the days when I was "young and foolish."

For the last year all load funds have been purchased through MFD (last year) or E*Trade (this year) to avoid the load.

Hope that helps.

Let's get back to mer's & there relation to total % retained by the fund company.

Let us keep it simple :

You invest $1000 once , the return is 10% per year . Let us use a 10yr. window , with a 1% mgt. fee./ yr.

Ok your 1st year $1000 + 10% = $1100 , mgt fee=$11.00

2nd year $1100+10%=$1210 , mgt. fee= $12 3rd year $1210+10%=$1331 , mgt. fee=$13.31

Keep going to year ten and you will end up with :

$2595.00 after 10 yrs. of investment with a total of

$155.00 in mgt. fees .

Divide $155 by $2595 and you get about 6%.

Double the mgt . fee to 2% and you get 12%

These are not scary % 's what is the panic .

With 3% mgt. fee , you are looking at 18%-- PANIC

** This assumes the mgt. fee is paid outside the investment to simplify the example.

Too simple !!!! or am I a simpleton.....

WOW! Thanks Bylo. I can see why you don't need an FP.

Hi Simple -- Your calculations are a little too simple. To illustrate, in your second year you compound $1,100 when in actual fact you only have $1,089 (ie. [1000 + 1000(.1)] - [[.01 x [1000 + 1000(.1)]] = 1189). This mistake is repeated and makes a large difference over time.

An easier, and accurate, way to determine the effect of MER is to use the following general formula:

(1-MER)ⁿ

For a 1% MER over 10 years you will get the following:

(1-.01)¹⁰ = .904 --> Which you would interpret to mean "My portfolio grew to 90.4% of what it would have if there was no MER".

For 2% MER the result = .817

For 3% MER the result = .737

So instead of the negative impact of 1%, 2% and 3% MERs being 6%, 12% and 18% respectively, the impact is actually about 10%, 18% and 26% respectively.

I hope this clears things up for you (and I also hope my HTML tags for subscripts also works).

Here's an excellent article on MERs from Saturday's post that includes gummy's chart:

Bylo,

Regarding Gordon Powers article is it all about costs or performance? Do you chose a fund based on its MER or on it's performance? Which are by the way after MER's. You own Trimark Fund and Templeton Fund which are excellent choices by the way. Obviously this has to do with performance doesn't it? These are excellent choices by the way. Please explain the rational for index funds versus actively managed funds. If I look at the performance of Cdn equity fund over the last five years there are 45 funds that have outperformed the TSE 300. There are in fact over 20 funds that have exceeded the TSE by at least 3% per year after MER's and at least 7 that have exceeded the TSE index by a full 10% per year. I would certainly like to see a copy of the study Gordon Powers quotes. Is that possible? Regards.......Bottom line

Rob,

huh?

It is refreshing to see how Canadian investors are becoming increasingly sensitve about costs which greatly erode into their mutual funds. The concern at loads creates an enlarging market for discount brokerages like Action Direct, and for 0% front- load dealers like Mutual Fund Direct, E*Trade, Amex Fundsource, Sterling Mutual, Source Mutual, etc. We should take more interest on the other cost, Managed Expense Ratio. Even the lower MER of index funds in Canada, .9% of CIBC & .8% of TD, is too high when compared to .2% of Vanguard index funds in US. Readers, show your support for low MER. Refer to the thread: I e-mailed Vanguard.

Bylo, or anyone else for that matter,

If we compare TIPS and PH&N Canadian equity fund. They both behave relativaly the same, and the PH&N fund has a very low MER.

Between the two, I prefer the PH&N fund simply because I like to have someone at the helm.

Working within your comfort zone is just as important if not more than reaching for the ideal IMHO.

Comments?

Gilles,

True to my Canadian upbringing, I compromised and now I own both :-)

Re comfort zone, GlobeFund reports the 3-yr risk of PH&N Can Equity is 12.2 and TSE 300 is 11.82. The 3-yr betas are 1.01 and 1.00 respectively.

Statistically-speaking the former is slightly more volatile than the latter, but I manage to sleep well regardless. :-)

Well said Joe, anybody on this site who hasn't e-mailed Vanguard yet should stop complaining about high MERs ;=)

Some investors may not realize the difference a couple of percentage points make over the long term,so I worked out some numbers that might interest you. To keep it simple I used a 10% and 12% annual net return.You might think that the difference is only a measly 2 %,but you miight be short a million bucks at retirement time .At 10 % your money doublesapprox every 7 years,at 12% it doubles every 6 years. If you are 23 years old and invested $ 15625 here is what would happen to your investment:

   
10% return  

Age 23 $15625  30  31250  37   62500  44  125000  51 250000  58  500,000   65  1,000,000 

12% return  

Age 23  15625  29  31250  35   62500  41  125000  47 250000  53  500,000   59  1,000,000   65  2,000,000 

Sure makes you think Doesn't it.