Morningstar has given Canadian fee rates an official thumbs down. Find out why we are getting such poor marks. What goes into making up a fee rate? Why is unbundling your fees advantageous and how do we stack up? Listen today as Senior Financial Advisors Rob McClelland and Mike Connon break down the mystery behind fee rates.
“Key Points”
Fee Rates
ETFs
Mutual Fund Rates
Canadian Fees vs. U.S. Fees
Graduated Fee Schedule
Active Management
Fee Deals
Management Fees
Investor Behaviour
Transcription
Rob (00:00):
Hello, this is Rob and Mike from The McClelland Financial Group of Assante Capital Management, and this is Think Smart with TMFG. Today on Think Smart with TMFG Mike and I are going to be discussing the headline Canada Gets A Below Average Grade On Investment Fund Fees. Mike, this is a recent Morningstar report that said Canada is getting a below-average grade on total investment fees relative to the rest of the world, thoughts?
Mike (00:40):
Well Canada’s fees, are they up or are they down in the last couple years?
Rob (00:44):
Fees are trending down, so fees are continuing to go down, and I think a lot of that is being driven by the ETFs, or exchange-traded fund fees, are dramatically lower. A lot of fund companies have come out with ETF versions of their regular mutual funds, and you’re seeing whether it’s a 25 or 50 basis point reduction in the total fees. Although all that being said the average balance fund in Canada is still 2.43% as of the end of 2021.
Mike (01:20):
That’s pretty expensive.
Rob (01:22):
That very expensive.
Mike (01:23):
But the one thing that’s interesting is they always compare fees just to the United States, they never really talk about the rest of the world. I’ve had clients in move to different countries and you’d be blown away by how much better North America is with investment options than the rest of the world, and how expensive it is in other parts of the world to actually get investments. So I guess we are comparing ourselves to the cream of the crop when we go to the U.S., that’s probably the cheapest management fees in the world too.
Rob (01:48):
I think it’s helpful maybe to break it down, in our lingo we call it unbundling, and so I’m going to break down the components of the total fee that a client would pay. And so the first thing is the expense ratio of the fund. So they have to produce reports, there’s trading expense ratios, there’s tax on all of that so there’s an expense ratio, and that’s somewhere between 15 and 50 basis points per fund.
Mike (02:29):
Yeah.
Rob (02:29):
So that 0.15 to 0.5% of that 2.43 that we talked about is an expense fee.
Mike (02:33):
Yeah. You forget sometimes as we’re doing tax returns, they need an accountant to basically audit and do tax returns for these funds. And in addition to that they need a trustee to hold the assets and do the trades too. So there’s more than just what you’re paying to the actual manager.
Rob (02:50):
And they have to have that value right every day as to what that mutual fund is worth. What are all those holdings and the mutual funds, all the money that came in that day, all the money that went out, so there’s an expense ratio.
Rob (03:04):
The next thing you have is the manager fee. So if you are paying for active management in this country you’re going to pay that manager, they’ll receive somewhere between let’s say 25 basis points and 1%. So between 0.25 and 1%. And if the fund goes up their fee goes up along with it, if the fund goes down their fee goes down along with it, it’s a percentage fee and it’s listed in the prospectus as to what that fee is. So that’s the second component of the fee. What’s the third component Mike, what’s that called?
Mike (03:44):
Third component would be the advisor component. So the advisor component would be the amount that someone like ourselves would be paid to run the fund. So whenever there is a fund, usually out of their total management fees, if it’s an A Class fund that’s a bundled type of mutual fund, they’ll pay the advisor a certain amount to maintain the fund. And that generally ranges around probably the 1% range.
Rob (04:08):
So we started with that 2.43, if the advisor is getting 1% and let’s say the manager is getting 1%, and there’s 25 basis points of expenses, and then you put some HST on top of it, now you’re at 2.43%. So we learned a long time ago the advantage of really unbundling those fees. And so what you’re doing there is that the manager still gets paid, so they collect their fee, whatever that is, and so we happen to use dimensional fund advisors and they charge about 25 basis points for their fees, so they’re on the low end. Some of the managers in Canada charge a full 1% or even higher, so dimensional would be in probably in the top 10% of lowest fees just on the manager side. The expense thing is what it is, it’s whatever that particular fund costs to manage. Funds in Canada and North America are a little cheaper. Once you start getting outside of Canada the expenses go up as you mentioned.
Mike (05:17):
Yeah. I guess there’s a few real advantages to unbundling those fees too, to separating what you’re paying for the actual mutual fund and what you’re paying for your advice, because they really don’t have much to do with each other, they’re really two separate issues. So the idea of bundling them all together in one fee doesn’t make a ton of sense. So when you get into the area where you’re paying your advisor, number one from a tax point of view it’s a big advantage because anything you pay to your advisor is generally for your open accounts is a fully tax deductible expense. And when we talk about that it goes early on in your tax return too, which means it can actually reduce the amount of OES claw backs and things along that line. So it helps quite a bit as far as how much taxes you pay.
Rob (06:03):
The other thing I find when you unbundle you can start to move that fee around. So for example for TFSAs, and we’ve talked about this in previous podcasts, for the tax free savings account we have that fee actually come out of the open account, so that TFSA account grows faster free of tax. In some cases if you wanted to you could charge the RSP fee from the open account. Now it’s not tax deductible and you may not want to do that, but that’s another thing you could do. You could even on an RESP, you could charge the fee into different places. So there’s flexibility in it.
Mike (06:41):
And beyond that there’s some independence that comes with that. We’ve always talked about this, whoever pays you as your boss. And at one point in time we were being paid by the mutual fund companies. I mean it was the clients who pay the mutual fund companies but the mutual fund companies were paying us, and this is back 15, 20 years ago. Right now clients are paying us so they’re our boss, and you’re going to do whatever is best for the person who’s paying you. And it really eliminates that conflict of interest rather than having a mutual fund company that’s paying your way. We’re being paid by the clients to choose the best investments to make their plan work.
Rob (07:16):
Go back a number of years ago you could have one manager that would pay you a 1% fee and others would pay you one and a quarter percent fee, and others would pay you 50 basis points, and some others would pay you nothing. So who do you think you’re going to direct your client to? And that’s not good, that’s a conflict of interest.
Mike (07:37):
It’s hard to give non-biased advice when pay is being affected. And it was a terrible point of the industry because you remember when that was the case, sometimes you’d get as you said you get paid an extra 25% by using one investment over the other. It wasn’t right.
Rob (07:53):
In terms of, I’ll use the banks as an example, so they offer both, so if you happen to work with the brokerage arm for the bank there’s a pretty good chance you can get your fees unbundled, but if you just work at the branch level those fees tend to be all bundled. So it depends partially if you’re working with the brokerage arm typically you’ve got more than $750,000 or a million dollars, and then they’ll have you work with the brokerage arm, that’s not always the case but more often than not. So you can get both bundled and unbundled in the bank model.
Mike (08:28):
I guess the big thing we didn’t even talk about is the ability for the fees to drop with the amount of assets. When you bundle your fees together, whether someone has $10,000 or someone has $10 million, they’re paying the same fee, right, it’s not in any type of fund, there’s no differentiation between the different types of investors. When you unbundle those fees advisors can lower the fee for larger accounts, and which seems to be more of a fair type of situation.
Rob (08:58):
We’ve been able to do that, we’ve got a graduated fee schedule so the more assets the client has the lower percentage the fee becomes. We’ve also been able to create family fee deals and lower fees for younger clients until they’re more established. There’s a lot of talk about exchange traded funds and they are dramatically cheaper but once you put the advisor fee in then you’re comparing apples to apples. So ETFs, you can buy ETFs for 10 basis points, 15 basis points, but you’ve then got to put the advisor fee on top of that. We see some firms on the radio saying that you can retire 30% richer because your fees will be lower, but they’re not offering advice. They’re saying you can buy these cheap items but you’re having to make all the decisions. What does the evidence show?
Mike (09:53):
The evidence shows quite the opposite. I looked at some reports that came in that show relative performance was well under from some of these robo advisor firms and what they would get with a properly managed portfolio with a full investment firm. And again, people tend to make mistakes on their own, and what these areas can’t control is?
Rob (10:16):
Investor behavior.
Mike (10:17):
Yeah.
Rob (10:18):
It’s the biggest enemy out there, and we’ve talked about this in numerous podcasts, how difficult it is. We’re in a little bit of a downturn right now, there doesn’t look like there’s any good place to invest. Bonds are down, interest rates are high, inflation is high, stocks are down, real estate is struggling except if you talk about residential real estate.
Mike (10:43):
Well you find right now too when you look at all these types of firms too, it’s all crypto that they’re going on right now, because they found a way to charge higher fees through crypto trading, right? So there’s some hidden fees inside there, it’s a high profit margin for these companies and they’re pushing that crypto are because that’s where they can make money right now. And unfortunately it’s getting a lot of our youth to go and try to use as a gambling website, rather than betting on sports they’re betting on cryptocurrency so it’s not a great thing.
Rob (11:11):
So if we look at the news about this are Canada’s fees still too high? Maybe a little but not by much, maybe 10 to 15 basis points too high. Once you unbundle it and you do an apples to apples comparison they’re actually not dramatically different. So to me there’s three good things going on. Fees are continuing to come down, there’s increased transparency, people can find out what’s in that 2.43% if that’s what they’re paying. And finally, there’s a lot less conflict of interest in the industry, and I think that’s a good thing for all investors.
Mike (11:50):
Absolutely.
Rob (11:51):
That brings us to the end of another week, thank you for joining us. This is Rob and Mike with Think Smart from the McClelland Financial Group of Assante Capital Management, reminding you to live the life that makes you happy.
Assante Capital Management (12:26):
You’ve been listening to The McClelland Financial Group of Assante Capital Management Limited. Assante Capital Management Limited is a member of the Canadian Investor Protection Fund, and the Investment Industry Regulatory Organization of Canada. Insurance products and services are provided through Assante Estate & Insurance Services Incorporated. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources. However, no warranty can be made as to its accuracy or completeness. Before acting on any of the previous information please make sure to see a professional advisor for individual financial advice based on your personal circumstances. The opinions expressed are those of the authors and not necessarily those of Assante Capital Management Limited.
