Fund Investing

Industry averages mask fee differences by distribution channel.
By Morningstar Canada | 23/02/15

Editor's note: Today's first installment of a two-part series on fund fees in Canada is based on findings published in the February/March issue of Morningstar magazine. The research was conducted by a three-member Morningstar Canada team consisting of Paul D. Kaplan, director of research, manager-research analyst Achilleas Taxildaris, and former analyst Salman Ahmed. Today we outline the main distribution channels for mutual funds and the fund-fee structures associated with them. In part two, publishing on Tuesday, we will break down the various elements of the total costs of fund ownership.

About the Author
Morningstar Canada, a subsidiary of Morningstar Inc., is a leading provider of independent investment research and data. We provide extensive reporting, analysis and commentary on investments and personal finance. The editorial team can be reached at feedback@morningstar.com with your comments and questions, but we cannot provide personal advice.

Broad industry averages for mutual-fund fees can be eye-catching, but they don't provide a way for Canadian investors to compare the amounts they are paying for their funds to what similar investors are paying for theirs.

As in other countries, many Canadian mutual-fund providers offer multiple share classes for each of their funds. The share classes are targeted to different kinds of investors and come with different fee structures, depending on the advice and service the investor expects.

Fees can also be vastly different between asset classes. Generally speaking, fixed-income funds tend to be cheaper than equity funds, and large-cap equity funds can be cheaper than small-cap funds. These differences get lost in industry-average figures.

To make meaningful comparisons, we divided fund share classes by distribution channel and by asset class. We then calculated average fees for each distinct group. This exercise revealed significant fee differences between distribution channels and gives investors meaningful benchmarks for fund costs.

Trying to get a sense of the distinctions between share classes isn't simple in Canada, or wasn't until quite recently. There is no uniformity in the monikers that fund companies use to identify share classes. While funds that are distributed through discount brokers are commonly identified as a D series, some companies may use other letters. Investors can read prospectuses to try to figure out the differences, but this exercise may be time-consuming and confusing.

To complicate things further, large fund sponsors like CI Investments, Dynamic Funds and Mackenzie Investments offer more than 10 share classes for each of their funds. So if you short-listed just one domestic bond fund from each one of these three fund providers, you'd now have the difficult task of sorting through at least 30 share classes to find the three most appropriate for your portfolio.

In order to make sense of this alphabet soup, the Canadian Investment Funds Standards Committee (CIFSC) last year devised a way to categorize share classes by distribution channel. The CIFSC is a private-sector group with representation from Canada's major mutual-fund database providers and research firms, including Morningstar. Its mandate is to standardize classifications for Canadian-domiciled mutual funds. One of its major roles is to place funds into categories like Canadian Equity, Global Neutral Balanced, High Yield Fixed Income and so on.

The CIFSC's four main share class categories are:

Commission-based advice. These classes of funds are for investors who rely on advisors to provide services such as fund selection, asset allocation and financial planning. The management fees include the costs of compensation paid to brokers and dealers by the fund companies. This compensation includes trailer fees, which are ongoing commissions paid to salespeople for as long as the investor continues to hold the fund. Advisors get a part of this trailer fee as compensation for work they do for investors. Similarly, distributors receive point-of-sale commissions from fund companies on the sale of deferred-sales-charge funds. Portions of these commissions are in turn paid to the individual salespeople.

Fee-based advice. These share classes are also bought through an advisor. But in this case, the fund's fees do not include trailers or any other embedded advisor compensation. Instead, investors negotiate compensation as a percentage of assets directly with their advisor.

Self-directed. These share classes are designed for purchase through discount brokers. They will have a reduced trailer fee, or in some cases no embedded sales compensation whatsoever. A small group of do-it-yourselfers use fee-only advisors (not to be confused with fee-based advisors). Fee-only advisors charge an hourly or flat rate for building a comprehensive financial plan. These advisors may direct their clients to use exchange-traded funds (most of which have no embedded compensation), or mutual funds that are targeted for do-it-yourself investors, to implement the financial plans.

Institutional. In this distribution channel, large investors like pension plans, trusts and estates negotiate fees directly with the fund company when making large investments. Wealthy investors, such as those that employ the services of investment counsellors can, at the discretion of the fund company, also purchase institutional classes. These classes are commonly designated by the letter I or O, but this too depends on the fund company.

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