Canada has the reputation abroad of a dull country, populated by honest people, and regulated by well-intentioned police officers in red uniforms mounted on horses. But does this comforting, but not very exciting, image apply to Canada’s financial markets, and particularly to mutual funds? A comparative world study of mutual funds by Morningstar reveals a less flattering portrait of Canada.pbgkevh2x6

Introduction

In May 2009 the U.S. company Morningstar (that has a Canadian subsidiary ) which specializes in evaluating mutual funds published a 118 page comparative study doc.1328 on the treatment of investors in mutual funds in 16 countries. For more on this report, see:

http://blog.canadianbusiness.com/canadian-mutual-funds/ 

http://www.canadiancapitalist.com/our-world-beating-mutual-fund-fees/

http://www.financialpost.com/personal-finance/story.html?id=1590409

http://www.steadyhand.com/industry/2009/05/13/morningstar_study_investor_experience/

http://network.nationalpost.com/np/blogs/wealthyboomer/archive/2009/05/13/us-mutual-funds-get-overall-quot-a-quot-in-morningstar-study-of-16- countries-Canada-flunks-for-high-fees.aspx

The purpose of the report

Here's how Morningstar describes the purpose of the report:

Much has been written about the rights of the shareholders of common stock, from a global perspective. It is well known that some jurisdictions safeguard the rights of stockholders better than do other jurisdictions. These policy differences have sparked debate, and the gradual development of "best practices" documents. The goal of this report is to begin a similar dialogue about best practices, only from the perspective of the mutual fund shareholder. (Although some of the questions in this report apply only to smaller, retail investors, other issues apply equally to retail and institutional owners. Therefore, this report should be interpreted as applying to all fund shareholders, not just individual investors.) Just as with stocks, some jurisdictions offer relatively friendly investment climate for mutual fund owners, and others less so. This report analyzes 16mutual fund marketplaces, highlighting their strengths and weaknesses. The findings are summarized through a series of scores. These scores into grades roll up at the topic level, and then eventually into a single final grade for each country.

General Conclusion

The USA placed first overall, while Canada received a B minus note, placing it in the middle of the pack (7th among 16 countries). But this rating hides a major deficiency.

Fees and costs: poor results

Canada (p.13) received a grade of F for the level of costs and expenses incurred by investors in mutual funds, which placed it last. Here is the commentary of Morningstar:

The typical expense ratios for fixed-income, money market, and equity funds are from 0.76% to 1.00%, 0.40% to 0.89% and 1.50% to 1.99%, respectively. For fixed-income funds, investors in Australia, China, and the United States enjoy lower expense ratios, while Canada, Hong Kong, New Zealand, Singapore, Taiwan, and the United Kingdom have higher fees. For money market funds, expense ratios are lower for Japan, Netherlands, Singapore, and Taiwan, and they are more than 0.90% in Australia and Spain. For equity funds, the U.S. is the only country with an expense ratio lower than 1.00%, and investors in Australia, China, and New Zealand have expense ratios between 1.00% and 1.49%. Investors in Canada and Japan typically pay between 2.00% and 2.50% for equity funds. We encourage fund companies in Canada and Japan to lower their fees and expenses for the benefit of the investors. (Emphasis added)

Canada: specific comments

Here are specific comments relating to expenses levels in Canada:

The typical investor in a Canadian fixed-income fund has MER of between 1.25% and 1.49%. The typical investor in a Canadian money market fund pays a MER of between 0.40% and 0.89%. The typical investor in a Canadian equity fund has MER of between 2.00% and 2.50%. Canadian investors do not pay much attention to fees. Canadian investors are comfortable with the fees because they do not know how low these fees should actually be. Assets tend to flow into average-or higher-fee Canadian funds because investors use financial advisors to help them make decisions. Advisors direct client assets to funds that pay better trailers. And since the trailer is included in the MER, the result is that assets flow into higher-fee funds. (emphasis added)

Fees and expenses

Canada's failing grade in fees is the lowest grade received in any of the surveyed areas. Canada has notoriously high management expense ratios. These high fees have been documented in multiple studies, including "Mutual Fund Fees Around the World" (Khorana, Servaes and Tufano, 2006). The article states, "Funds domiciled and sold in Canada have considerable higher costs than those sold in its North American neighbor, the U.S." (emphasis added)

Our conclusions

Readers of our site know the importance we give to managing carefully your investment costs (see Costs of investing ), and the unenviable position of Canada (see In Canada- the big picture ). The Morningstar report confirms Canada’s poor ranking, but goes further by accusing Canadian financial advisers of causing this situation by directing their customers to funds with high expenses, particularly trailer fees. Morningstar describes the situation in Canada as notorious. We would add that only the Canadian mutual fund industry denies this, while Canadian securities commissions simply ignore this disgraceful situation (see no evil). Our recommendation: avoid actively managed funds (which are typically the funds with high fees), and invest in index funds (the exchange-traded funds, otherwise index mutual funds); see Index Funds ( ETF’s and index mutual funds) on our site . And if you have a financial advisor, discuss with him why he does not recommend index funds.

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