MERs falling? Investor Economics weighs in on fund fee debate

(July 17, 2003) There’s no question that management expense ratio (MER) fees for mutual funds have risen over time, but most of those increases came in the late 1990s, according to a recent Insight report from fund researcher Investor Economics. MERs have actually been falling since 2001, the report concludes.

Following on the heels of Morningstar Canada, Investor Economics conducted its own MER analysis, paring down the fund universe “to compare apples to apples,” and excluding segregated funds, wraps, hedge funds and labour-sponsored funds. It found that the average asset-weighted MER has dropped since the beginning of 2001, to 2.02% from 2.09%. “Overall the rise in MERs was fairly modest during the 1995-2003 research period, averaging 17 basis points.

“In general, MERs rose during the later 1990s and then appeared to peak in 2001 before heading down,” Investor Economics says.

Morningstar’s results were similar: its dollar-weighted average MER rose to 2.13% in 2003, compared to 1.93% in 1995, although the number has been relatively flat since 2001.

Numbers aside, it’s important to keep in mind that MERs are not the only cost to the fund investor, Investor Economics adds, citing evidence that other fees, such as trading costs, are declining.

“So even if MERs have gone up, the actual cost to the consumer has likely gone down,” Investor Economics says, adding that the real cost would be almost impossible to calculate, because individual circumstances vary dramatically.

“MERs are useful in comparing peer funds and as indicators of how the fund industry’s revenues are evolving and where some pricing pressures may be occurring,” the report says. “But it is important to bear in mind that they are not the last word and their significance will diminish as the industry evolves.”

In addition, mainstream media reports about MERs fail to distinguish between the management fee paid to the fund sponsor and the money spent on operational expenses, Investor Economics explains. “This leaves the public with the impression that the MER goes entirely to the fund company’s coffers.”

Still, the flap over MERs is an issue for the fund industry, Investor Economics insists, noting that investors are “MER-illiterate” because most of their experience reflected the 1990s boom. “Who cared about a 2.5% MER when funds were kicking out 15% to 20% a year or more? The prospect of single digit returns going forward will lead more people to question the wisdom of fund investing.”

And Investor Economics expects that means the fund industry will be forced to cut MERs, since “status quo pricing” is not an option for a maturing industry that’s under pressure from all sides. “As more alternatives come to the fore, the discipline of the marketplace will force fund companies to apply the same cost-cutting rigor to the funds they sponsor,” the report concludes. “We believe that going forward, MERs will be trending down, not up.”

Will the drop in MERs the Investor Economics report predicts get investors back into mutual funds again? If not, what will it take? Discuss this issue with your fellow advisors in the Talvest Town Hall on Advisor.ca.

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