Why cost of mutual funds is dropping in Canada, U.S.

The growth of mutual fund assets in both Canada and the U.S. has been driven by the advice industry since the 1990s — this was one finding in a 2012 Strategic Insight report commissioned by IFIC and then updated in 2015.

Fast forward to today, and it seems little has changed, says an updated version of the report released Wednesday.

The new report reiterates what was found in 2012: that the majority (more than 80%) of mutual fund asset holdings in Canada are accounted for by advice channels.

And the same is still true for the U.S., it adds. The 2017 report confirms most American investors (approximately 80%) still “rely on a financial advisor exclusively, or for a significant portion, of their investments,” if you exclude funds held through employer-sponsored retirement plans — those represent “an estimated 26% of mutual fund assets.”

What has changed, however, is the cost of ownership (CoO) of actively managed mutual funds for investors working with advisors — on both sides of the border. (Throughout, the report’s findings apply to such funds, and passively managed funds and ETFs aren’t considered).

As the updated report notes, “In the two years since the 2015 update […] most Canadian mutual fund companies have taken steps to reduce their management fees and other fund expenses.” That’s resulted in “an aggregate asset-weighted pre-tax CoO of funds that is six basis points lower in 2016 than was reported in 2014,” the report adds, saying “the rate of taxes levied on funds has remained unchanged during the period.”

In the U.S. “the cost of ownership of [actively managed] mutual funds also declined during the period in review. […] The decrease was due to reductions in the funds’ total expense ratio. […] Both the high- and low-range of typical portfolios’ embedded fund fees was 10 basis points lower in 2016 than in 2014.”

Overall, if the taxes levied on embedded costs and other fees are excluded, the report finds “the average Canadian CoO is 1.96%, nearly equal to the estimated average [of 1.95%] in the United States.”

If actively managed mutual funds are purchased without advice, the report adds, the total cost of ownership “declines considerably,” especially in the U.S.

Deep dive into advisor fees

As of 2012, both Canada and the U.S. had started to shift away from investors having to pay “for the advisor’s services at the time of purchase (transactional costs) and toward paying for such services over the duration of the investment.”

At that time advisors who were offering mutual funds in the U.S. predominantly used “the unbundled fee-for-advice model,” compared to the embedded fee model that was used by many advisors who were offering mutual funds in Canada, the 2012 report said.

Of course the ban on embedded commissions in Canada has been a hot topic this year, and such a move by CSA could lead to major changes — policy on embedded commissions will be published in early 2018 and, in the meantime, the ASC will hold forums later this month that will be similar to Ontario’s September roundtable.

Read: Clashing views at embedded fee roundtable

Still, the 2017 report revisits this point, noting that fees in the U.S. typically fall between 1% and 1.5%, when you consider both smaller investment accounts (those below US$100,000) and larger investments (those totalling more than US$1 million). Including external fees, the report adds, “Strategic Insight estimates the average cost of ownership for mutual fund relationships guided by a financial intermediary in the United States to be approximately 1.95%.”

Fees in Canada remain comparable, the report says, provided you’re considering “the average cost of ownership incurred by a typical fee-based investor in the U.S. who has chosen to be guided by a financial advisor.”

Overall, the report highlights, the move toward unbundled fee-for-advice models isn’t driving the CoO lower. Rather, “The cost reduction was largely the result of declines in underlying fund management fees.”

Read the 2017 report.

Additional IFIC findings (2017)

• In both Canada and the U.S., mutual fund assets under management increased by nearly 20% over the two-year period ending December 2016.
• At the end of 2016, no-load funds and front-end fund options with waived point-of-sale commissions accounted for 83% of industry assets at the end of 2016 — up from 77% in 2014.
• More innovation has been seen in the U.S. due to the scale of the mutual funds industry.