Understanding Mutual Fund MERs

Before we can fully appreciate whether we are paying too much for our mutual funds, we need to understand exactly what we are paying. (Jupiterimages/Photos.com)

With all the media hype surrounding the high cost of mutual funds in Canada, many investors naturally assume that they are being ripped off. The reality is that yes, fees are high, but there are many other factors to consider before we can say with certainty that you are being taken to the cleaners.

Before we answer the question of whether you are being ripped off, let’s take a deeper look at the cost of a mutual fund. Often times, this is referred to as the management expense ratio, or MER. The MER is really a mix of four different components: investment management, dealer compensation, operating expenses, and taxes. Here’s a quick look at what’s involved with each.

Investment Management

The investment management fee is paid to the portfolio manager and is intended to cover the cost of managing the portfolio. Quite often, the more involved the investment process, the higher the investment management fee.

This is one of the reasons a number of specialty mandates, for example emerging markets or health care, tend to be more expensive than broader equity mandates. It is more costly for the investment manager to conduct research, and in some cases, trade execution and custody costs can be quite expensive. This also helps to explain why bonds and money market funds tend to be less expensive than equity funds.

Dealer Compensation

This is an annual commission paid to your adviser’s firm to compensate the firm for providing you with investment selection and financial planning services.

Expenses

This includes things that go beyond the investment management costs and covers such items as legal fees, audit costs, printing costs, and other similar expenses.

Recently, a number of firms have switched to a fixed administration fee instead of having the investors pay the operating costs out of pocket. The jury is still out on whether or not it is a good thing for investors. However, it does provide cost certainty, whereas paying the operating costs can result in fluctuations year over year.

Taxes

The final component to the MER is the taxes that the fund must pay on various other components. Because investors live all across Canada, fund companies have the option of paying a blended rate of HST, based on residency. This allows the fund to pay a rate less than the 13 percent they would have to pay if they were required to pay the HST based on the fund company being located in Ontario.

To get an idea of how this looks in reality, I broke out the MER of the front-end version of the CI Harbour Fund (CIG690). With a MER of 2.43 percent, it is right in line with most other Canadian-focused equity funds. Its breakdown looks like this:

Cost
Investment Management Fee	1.00%
Dealer Compensation	1.00%
Operating Expenses	0.20%
HST	0.23%
Total	2.43%

Bottom Line

Before we can fully appreciate whether we are paying too much for our mutual funds, we need to understand exactly what we are paying. By breaking the MER into its various components, you can see where your money goes. Once you understand that, you are in a better position to determine whether or not you are paying too much.

Courtesy Fundata Canada Inc. 2013. Dave Paterson, CFA, is the Director of Research, Investment Funds for D.A. Paterson & Associates Inc. This article is not intended as personalized investment advice. Investment vehicles mentioned are not guaranteed and involve risk of loss.