Fund costs fell after CRM2

Research from the Canadian Securities Administrators (CSA) finds fund costs declined and risk-adjusted performance improved in the wake of client relationship model (CRM2) reforms.

The regulators published a pair of reports on Thursday examining trends in fund costs and performance from 2013 to 2020. The CRM2 reforms, which sought to improve the transparency of fund costs and performance for investors, took effect in 2016.

“The main findings of the reports reflect positively on investment fund industry trends, as both average fees declined and investment performance improved over the study period,” said Stan Magidson, chair of the CSA and CEO of the Alberta Securities Commission (ASC), in a release.

Specifically, the asset-weighted average management expense ratios (MERs) for mutual funds declined by 38 basis points (19%) between 2013 and 2020.

Average fund costs dropped through a combination of assets shifting toward cheaper funds and fund companies reducing MERs. Assets migrating to cheaper funds had a bigger effect than reduced MERs both before and after CRM2 was adopted, the research found.

Average asset-weighted MERs for ETFs declined over the study period by eight basis points. The smaller decline was expected “primarily because the majority of ETF assets are invested in funds that employ a passively managed investing strategy,” the research noted.

The regulators also found the risk-adjusted performance — alpha — generated by both mutual funds and ETFs improved between 2013 and 2020.

Average annual gross total returns for the period captured by the research was 7.1% for mutual funds and 7.9% for ETFs. But after accounting for risks, both types of funds produced negative alpha, the research found: “[T]he mean gross alphas relative to our model benchmarks were -3.5% for mutual funds and -2% for ETFs.”

This negative alpha generation improved after the implementation of the CRM2 reforms, but remained negative.

“For mutual funds, the annualized average gross alpha was -5% between 2013 and 2016, and -2.2% between 2017 to 2020. The ETF findings were -4.8% for the pre-implementation period and -0.6% for the post-implementation period,” the research noted.

While cost and performance both moved in favourable directions after the CRM2 reforms were adopted, the research stressed that correlation doesn’t equal causation.

“It is important to note that the changes in industry behaviour cannot be directly attributed to the CRM2 amendments. Other factors, which could not practically be accounted for in the analysis, may have contributed to the changes,” it said.

Several other industry trends were underway during the study period, the research noted: the growth of fund wrap programs; the growth and evolution of the ETF industry; an ongoing shift from commission-based to fee-based mutual fund series; growing demand for ESG products; and the emergence of robo advisors.