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Mutual fund companies keep only two-fifths of annual fees charged investors

by Wayne Cheveldayoff, 2004-06-17

If you own mutual funds, you likely know that you are paying an annual percentage fee, known as a management expense ratio (MER), on your holdings even though the fee isnít displayed on the monthly or quarterly statements you receive.

What you may not know is that the fund company keeps only about 40 per cent of that fee. The remainder is paid out to your investment advisor and for other services, with the federal government also getting a cut through the application of the GST.

The fund prospectuses (filed with regulators at www.sedar.com and available on fund company websites) provide minimal information on MERs, which are typically 1 per cent annually for money market funds, 1.8 per cent for bond funds and between 2.5 and 3 per cent for equity funds. (MERs can be significantly lower in situations where sales commissions and trailer fees are not paid to an advisor).

A more-detailed breakout than is found in a prospectus was recently published by fund company Mackenzie Financial (www.mackenziefinancial.com) in a booklet entitled, Fees and Mutual Fund Investing: the Facts.

For an example showing where the fee goes, Mackenzie used its Ivy Canadian Fund, which has an MER of 2.51 per cent. That means for a $10,000 holding in this fund, you pay $251 annually to the fund company.

Of this $251, Mackenzie actually gets to keep only $102, which goes for corporate expenses such as marketing and to pay its portfolio managers and their research expenses. Naturally, some also ends up as a profit for the fund companyís shareholders.

Of the remaining $149, the biggest amount, specifically $98, goes to investment dealers to compensate their employee advisors for initially selling the fund (sales commissions) and then to provide ongoing investment advice (trailer fees). Some of this also is advanced to investment dealers to help pay for co-op marketing, such as newspaper advertising of seminars.

Another $35 goes for operating expenses, which include record keeping and reporting to investors, administration, audit and legal fees, and for an independent custodian to hold the fund assets and maintain them separately to protect investors from the possible business failure of the fund company.

Also, some of the operating expenses go to a transfer agent, which processes the buys and sells of mutual fund units and processes and pays dividends and distributions to investors on behalf of the mutual fund company.

Finally, $16 goes to pay GST on the management fee and certain operating costs within the fund.

A management expense ratio of 2.51 per cent for an equity mutual fund is at the low end of the range, probably because the Ivy Fund is one of the largest around. With large funds, the expenses can be spread over a lot more units than smaller funds, which is why MERs for funds with a small amount of assets are usually higher.

One type of expense that is not reflected in the MER is the trading commission the portfolio manager pays to investment dealers whenever buying or selling securities for the mutual fund.

For such institutional stock trades, these trading commissions are typically around 2 or 3 cents per share. The commissions are automatically deducted before the price of the buy or sell is recorded by the mutual fund and therefore donít show up as operating expenses. The total amount spent will depend on how much trading takes place.

The level of detail provided by Mackenzie goes beyond the standard statement of disclosure in a mutual fund prospectus.

The prospectus notes there is a ďmanagement fee,Ē which is typically 2 per cent for an equity fund, and that this fee covers all the costs of paying the mutual fund company for who decides how, and in which securities, the fund will invest, and of paying investment dealers and the financial advisor who sells you the fund.

But the prospectus doesnít provide further breakdown or explanation, although it usually notes the management fee is lower by 1 percentage point for F-class funds, which donít pay sales commissions or trailer fees to advisors.

While Mackenzieís more-detailed disclosure is a step in the right direction, investors really need greater visibility of fees right on their monthly or quarterly statements from investment dealers.

Currently, such statements show only the unit price or the fundís return, net of fees.

With modern computer technology, it should be possible to provide full information on monthly and quarterly statements of the MER of each fund, showing breakouts including how much is going to the advisor.

Without such information readily available, itís hard for investors to judge whether they are getting value for money.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.

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©2004 Wayne Cheveldayoff