MERs only part of the fee story, analyst says

(July 10, 2003) Although management expense ratio (MER) fees have been getting most of the attention recently, mutual fund investors should also be aware of brokerage commission fees, a hidden cost also borne by unitholders, says analyst James Gauthier of Dundee Securities.

Because brokerage commission fees are capitalized rather than expensed, they are excluded from the MER, Gauthier said in a recent report, and are simply included in the cost of securities purchased. He cites the example of a fund buying 100 shares at $10 each with a brokerage commission fee of $50. “Rather than showing the $50 as a separate expense, it shows up in the total cost of the shares,” Gauthier explains.

“As a result, the 100 shares would go on the fund’s books as costing $1,050 in total,” he says.

Dundee studied the financial statements of the country’s nine biggest fund firms to dig up more information on brokerage commissions. “Even the most frugal funds will have commission expenses, they are a part of the business,” Gauthier says. “However in several cases, the costs incurred due to commissions were exorbitant and lead to a total expense ratio that exceeded MER by a hundred basis points or more.”

At the high end of the scale, AGF’s Aggressive Global Stock Fund’s average brokerage commission over 2001 and 2002 was 3.04%. Add that to an MER of 3.21% and you’ve got a hefty 6.25% in total expenses. Similarly, Talvest’s China Plus Fund had an average brokerage commission of 2.79% combined with an MER of 3.2% for a total expense of 6%.

However, most brokerage commission fees were much lower, such as Trimark’s Select Growth at 0.08% and Templeton Balanced at 0.09%. On average, brokerage fees accounted for 0.35% in costs, the researcher found. A recent report from Morningstar pegged the average MER at 2.6%.

Funds with relatively high brokerage commission fees also tend to have very high levels of turnover, Gauthier says, such as momentum-oriented or aggressive growth funds.

“On the flip side, those funds managed using a buy-and-hold philosophy will tend to have very low turnover and commission numbers,” he adds.

So does that means investors should avoid funds with high turnover? Not necessarily, Gauthier says. “Heavy trading may be the only way a manager can truly execute his or her management style. However, high turnover raises the height of the hurdle the manager must exceed in order to beat the benchmark.”

Is the fees issue something you’ve had to deal with with your clients? How do you handle the issue when it comes up? Want to know how other advisors deal with the subject? Just ask in the Talvest Town Hall on Advisor.ca.

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