Canadian Mutual Funds: A Steep Price For Underperformance
Investors in Canadian mutual funds pay a steep price for underperformance. In a 2015 Morningstar report on mutual fund fees, Canada ranked dead last among 25 nations – with expense ratios on equity mutual funds averaging 2.35 per cent in Canada versus an average of 0.84 per cent in the United States.
Couple that with another sobering statistic: Canadians held $1.23 trillion in mutual funds as of October 31st, 2015.
Morningstar also found that about $37 of every $100 invested in equity mutual funds sold in Canada are in closet indexers: funds which are supposed to be actively managed but actually “hug” the market benchmark.
Related: How to get started with an index portfolio
Most consumers believe that you get what you pay for but, when it comes to investing, higher costs don’t correlate with better returns. In fact, academic research tells us that lower-cost funds outperform higher-cost ones over the long term and that the best predictor of future returns is the expense ratio.
I put that to the test when I looked at four TD e-Series funds – which happen to be Canada’s lowest cost index mutual funds – and compared them to TD’s more expensive (and more widely sold) mutual fund cousins:
| e-Series fund name | 10-year annual return % | 10-year growth of $10,000 | Management Expense Ratio (MER%) | Total fund assets (millions $) |
| TD Canadian index e-Series | 5.36% | $15,865 | 0.33% | $1,141 |
| TD Canadian Bond Index Fund | 4.54% | $15,554 | 0.50% | $663 |
| TD U.S. Index Fund | 8.27% | $21,757 | 0.35% | $1,058 |
| TD International Index Fund | 4.80% | $15,756 | 0.51% | $465 |
| Total | 5.74% | $68,932 | 0.42% | $3,327 |
| Mutual fund name | 10-year annual return % | 10-year growth of $10,000 | Management Expense Ratio (MER%) | Total fund assets (millions $) |
| TD Canadian Equity Fund | 4.82% | $15,113 | 2.17% | $2,919 |
| TD Canadian Bond Fund | 4.25% | $15,092 | 1.10% | $12,703 |
| TD U.S. Large-Cap Value Fund | 6.27% | $18,176 | 2.38% | $1,319 |
| TD Global Shareholder Yield Fund | 4.61% | $15,046 | 2.55% | $816 |
| Total | 4.99% | $63,427 | 2.07% | $17,757 |
The verdict:
An investor who contributed $10,000 into each of the four TD e-Series funds 10 years ago would have $5,503 more today than an investor who put the same amount into TD’s more traditionally-sold family of mutual funds.
Not only that, the e-Series investor pays just $287 per year in fees today due to the portfolio’s low 0.42 percent expense ratio. That’s nearly one-fifth the cost of TD’s actively managed mutual fund portfolio.
Related: My advice to switch out of mutual funds draws ire of industry group
So if an investor can make more money and pay less fees by investing in a portfolio of index mutual funds, why do the four actively managed mutual funds outsell the e-Series funds by more than a 5-to-1 margin?
That’s a question more Canadian investors need to ask of themselves and their advisors.
Glad to hear it! I abandoned TD’s high MER funds a while ago, the E-series have their pit falls (you can’t deal with them easily within the “TD Mutual Funds” accounts, but you can fix that by putting it in a TD Waterhouse account.
Rob, nice post. It is truly astounding that this situation exists. It is, or course, due the fact that unfortunately people go their bank for financial advice where they are not told about the e-series index funds and pushed into the expensive alternative for obvious reasons.The banks are simply breaching their fiduciary duty to their clients. What to do about it? It’s a difficult problem.
I’m in the process of moving my investments out of high MER wrap funds into ETFs. I’ve decided I will sleep better with 30% in lower cost mutual funds (MAW104/105). That may not be the best decision purely from a financial point of view, but it is best for my comfort level. Once I have the experience of holding ETFs for a few years, I may then feel comfortable moving the MAW money in.
Thanks for your continued efforts to highlight this Rob.
In 1999 Ted Gadsby the VP of mutual funds for CIBC wrote a book called The Power of Index Funds. ( Canadas best kept secret ) I wonder if they sacked him for saying thats what everyone should use.
Grant, the securities commission is working on this. Now clients are supposed to be given a fund fact sheet showing the fees and returns. In the summer of 2016 compensation has to be declared on statements. I really wish they were showing cost and performance to benchmark though not compensation. Half the time the sales rep does not even get all that compensation ( 20 to 50% to licence sponsor ) but people will be surprised how much it is and it is a distraction from the real issues.
Watch the tracking error on some index mutual funds. They are not cheap if they are not doing what they should. TD is much better than used to be, years ago it was way off the index some years.
There are a few actively managed funds that consistently outperform the index funds e.g Mawer. It pays to do your homework before investing.
Hi Gail, thanks for stopping by. The actively managed mutual funds that consistently beat the market (Mawer, Leith Wheeler, Beutel Goodman) have two things in common:
1). They cost significantly less than bank-sold mutual funds; usually in the 1 to 1.5% range.
2). They tend to have a high active share (as in, the majority of their holdings differ from the index).
Gail, true Mawer has an excellent record, but being actively managed, there is no guarantee going forward – managers retire etc.
You may be interested in this post by Justin Bender that shows that although Mawer outperformed the broad market, this was due to buying value stocks. In other words if the fund were compared to the appropriate risk adjusted index (a large value ETF), there is in fact no outperformance.
http://www.canadianportfoliomanagerblog.com/active-funds-exposed/
It looks like the active funds in your comparison show better results over the years, but it is not realized due to the cost. If the fees were the same or even an average of 1% less, the active funds would win. So they deliver better technical performance but do not make it worthwhile
Robert, It is true Mawer, and any other Fund Managers who may outperform on a somewhat regular basis, would have shown EVEN better numbers had they charged less ….. In fact, I think your company would be much more profitable if you worked for less … or for free even more so; then the amount otherwise paid in Salary & Benefits could go straight to the bottom line ….
Would you please consider getting the rest of your co-workers to agree to do the same charitable thing
If you read the article, the comparison was made within one company’s long term products. I’d say Robb’s analysis was a fair one.
I’d like to see the same comparison for the other major banks instead of always looking at TD.
Hi Chris, fair point and stay tuned – all the banks offer a suite of index funds (though not as inexpensive as TD’s e-Series funds) and I’m confident that we’ll reach the same conclusion.
I did buy mutual funds before… been there, done that!
That resumes it all! haha
But that’s an informative and interesting post.
Cheers,
Mike
What is the difference between the banks financial planner and financial planner one pays outside of the bank?
I do believe my Scotia iTrade Vanguard etc index funds come in much cheaper
VXC 0.27
VCN 0.11
VAB 0.19
Like the other Chris states there are other options out there.
Regardless the key point is that Canadian investors should really watch where they are putting there savings and realizing what they are actually getting in return.
Hi Chris, I used index funds in the comparison because they are still classified as mutual funds and you can see clearly how big of a difference there is in MER for funds which are supposed to do the same thing.
Some people don’t feel comfortable trading ETFs, but DIY investors who have a good handle on investing can certainly cut their fees down even further with ETFs.
and to think that several years ago I had money invested with Investors Group….yikes there was some hidden MER cash I won’t ever get back.