Active Management: You Don’t Always Get What You Pay For

By: Kathleen Clough

Too many investors perceive mutual funds to be a low-cost investment solution. But are they really? Not when you consider the hidden costs and the ongoing management expense ratio (MER) that is paid out of the assets in the fund. Couple this with the fact that the majority of mutual funds underperform their benchmarks, and we have a situation where investors are paying high fees, but not getting high returns to match.

The reason that many investors don’t understand this issue is that mutual fund fees tend to be buried within the fund rather than paid directly out of the investor’s pocket. For example, all mutual funds have a management expense ratio that covers the following costs:

1. Payments to the portfolio manager for researching and selecting investment opportunities
2. Operating expenses of the fund, such as legal, audit, trustee and custodial fees
3. Brokerage commissions for buying and selling securities in the fund

Complete details about these fees are covered in the Simplifi ed Prospectus and the Financial Statements provided by the mutual fund.

In addition, most mutual funds also pay trailer fees to advisors to compensate them for selling the fund, driving the MER up even higher. Because this fee is hidden, investors don’t realize how much they’re paying.

At PWL, our approach is different. We believe in keeping fees low, and ensuring complete transparency, so that investors know exactly how much they’re paying for our services. The only revenue we receive is from our clients – nothing comes from fund companies or product vendors. We charge a management fee which covers the tax-effi cient management of your account, performance reporting, regular communications with the fi rm and your ad vi sor, research for new asset class vehicles, and income tax reporting.

In addition, we select securities, such as exchange-traded funds (ETFs), that carry signifi cantly lower management fees than traditional mutual funds. For example, one of our offerings, Barclay’s iSharesTM CDN LargeCap 60 Index Fund has an MER of 0.17%, compared to an average of 2.4% for an actively managed Canadian equity fund. We seek out fi rms such as Barclay’s that have a policy of not paying trailer fees to advisors, in order to keep costs as low as possible.

What impact does this have on investment success? Reducing the cost of investing can have a dramatic effect on returns - only a 1/2% reduction in fees can result in a 10% increase in the value of a portfolio over a 20-year timeframe.

There’s also solid evidence that shows that the majority of Canadian, U.S., and inter national equity funds fail to perform as well as their benchmarks – in fact, in 2007, 91.6% of actively managed Canadian equity funds underperformed the S&P/TSX Composite Index. Only 8.4% were able to produce returns as good as or better than the index. In other words, there’s no correlation between high management fees and high returns; actually, the reverse may be true!

This research makes PWL’s approach a winner on both counts:

1. Low management fees with complete transparency for the investor
2. An emphasis on indexed products designed to capture market returns at the lowest possible cost

At PWL, you really do get what you pay for – and more!