MER report valid, but take a closer look at the numbers, analyst says

(June 12, 2003) A controversial report from Morningstar Canada analyzing rising management expense ratios (MERs) in the mutual fund industry is fair, one industry analyst has concluded. However, the increase in MERs is perhaps not as dramatic as it first appears, says Dan Hallett, senior investment analyst at Sterling Mutuals.

The report, released earlier this week, concluded that the average MER for all mutual funds rose to 2.62% as of April 30, 2003, from 2.02% in 1995. But Hallett says if you dig deeper, the report also reveals that excluding segregated funds, the average dollar-weighted MER is relatively flat at 2.13% this year, compared to 1.93% in 1995.

That’s just 20 basis points, which could be explained by the introduction of the GST and higher regulatory costs, Hallett says.

Dollar-weighted averages are more meaningful, the fund analyst argues. “A simple average MER looks at all the funds and does an average,” he told Advisor.ca. “Dollar-weighted average weighs each fund differently depending on how much the fund has in assets.”

As an example, Hallett takes a two-fund universe, one with 90% of assets and an MER of 2%, and the other with 10% of assets and a 5% MER. “A simple average would be 3.5%, but dollar weighting would come up with 2.3%,” he says. “So it’s more representative of what people are paying for the average dollar invested.”

In fact, Hallett believes a look at dollar-weighted MERs among the core classes of mutual funds over a period of time would show little change.

“If you put it in a graph, the line would be relatively flat,” he says. At the same time, there’s an argument to be made that dollar-weighted MERs should actually be falling, Hallett says, considering the explosive growth in fund industry assets over the last eight years.

IFIC president Tom Hockin has called the Morningstar report “highly misleading” and accused the fund researcher of comparing apples and oranges. Hallett says while some of the report’s finer details could be debated, the conclusions are valid. He believes fees are a sensitive issue for the fund industry, already hurting from a lengthy bear market.

“They don’t want any more negative news,” Hallett says.

Weigh in with your thoughts on the Morningstar report. How are your clients reacting, if at all, to the MER issue? Share your opinions about this issue in the Talvest Town Hall on Advisor.ca.

Filed by Doug Watt, Advisor.ca, dwatt@advisor.ca