Canadian investors get a ‘Below Average’ fee experience

In Morningstar’s latest Global Investor Experience (GIE) Study, the Fees and Expenses grade for Canada has improved, from dead last in the 2017 study, to ‘Below Average’ this time around.

Earlier today, Morningstar published the first chapter of its sixth biennial GIE report, which grades the experiences of mutual fund investors on a five-point scale – Top, Above Average, Average, Below Average and Bottom.

The report, authored by Grant Kennaway, Christina West, Wing Chan, Jackie Choy, Jose Garcia Zarate, Jonathan Miller, Germaine Share and Jackie Beard, covers 26 markets and has four independent chapters on Fees and Expenses, Regulation and Taxation, Disclosures, and Sales. You can find the first chapter here.

The authors find that globally, the trend continues towards lower fund fees, with the majority of the 26 markets seeing the asset-weighted median expense ratios for locally domiciled and available-for-sale funds fall since the 2017 study.

There are several factors that are driving the fees lower, including regulation in markets like the UK, Australia, India and some parts of Europe, increased investor awareness, unbundling of share classes (the authors note the growth of the ‘F Class’ (fee-based) shares in Canada as a notable example) and increased competition and disintermediation through the use of online channels, for example. Here’s a look at how the countries performed:

For a third study in a row, Australia, the Netherlands and the U.S. have topped the chart. “What these markets have in common is ongoing fund fees that are typically unbundled,” the authors note.

On the other end of the scale are Italy and Taiwan – Italy is a new addition to the Bottom grade, while Taiwan is a repeat from the last study. “Taiwan's asset-weighted median fees for fixed-income funds are the highest among markets in this study, partly driven by Taiwan's heavy concentration in funds that invest in higher-cost markets, such as emerging-markets debt and high yield,” the authors say. Italy meanwhile fell to bottom because individual investors are routinely subjected to initial charges and retrocessions.

Canada improves

Canada, meanwhile, moved out of the Bottom grade, to the slightly better Below Average grade.

“The improvement in Canada’s grade in this survey reflects the increased availability and uptake of retrocession-free share classes, as well as the insignificance of front loads in Canada,” said Christina West, Morningstar’s director of manager research services, North America and co-author of the study.  “While the grade remains held back by asset-weighted medians which are at times highest of all countries in this study, we are encouraged by the unbundling of fees, of which the growth of 'F class' shares in Canada is a notable example.”

The report shows that in Canada’s closed market, the asset-weighted median expenses are 1.94% for allocation, 1.98% for equity, and 0.99% for fixed-income funds. Typically, investors pay a 1.00% retrocession, or embedded trailing commission, for equity funds and 0.50% for fixed-income funds, though these numbers can vary slightly by fund provider.

In Canada, fund companies report the distribution channel for each share class: Commission-based Advice, Fee-based Advice, Do-It-Yourself, or Institutional. The table below illustrates the percentage of fund assets invested within each asset class by distribution channel for the retail share classes examined in this study.

The report also finds that the popularity of fee-based advice is growing in Canada, but a large majority of funds still pay a retrocession out of the management expense ratio to compensate fund dealers.

[Related: John Rekenthaler’s article on Canadian financial advisors]

The report also highlighted the Canadian Securities Administrator’s (CSA) proposed ban on embedded dealer commissions, and the subsequent September 2018 modified proposal to eliminate trailing commission payments to dealers that do not make a suitability determination. However it also noted Ontario’s rejection of the unanimous agreement among the provincial CSA regulators on how deferred sales charges would be phased out.

It also discussed the full implementation of the Client Relationship Model – phase 2 or CRM 2 in July 2017. CRM 2 is an initiative by the CSA to improve the reporting of investment costs and performance, under which investors started to receive detailed reports on the cost of their investment holdings. 

A note on ETFs

Canada-listed exchange-traded fund assets are about a tenth of the size of mutual fund assets. Retail investors are estimated to hold 60% of ETF assets, according to Investor Economics.

“Canada does not allow individual investors to buy mutual funds registered in other jurisdictions, but Canadians do have access to ETFs listed outside of Canada, which make up less than 20% of Canadian ETF assets. About one third of retail ETF assets are held at online or discount brokerages. There are no tax regulations that make the use of ETFs financially unattractive for the most part. However, while ETFs accumulate capital gains that the investor must pay taxes on, the gains are automatically reinvested in the funds, making the capital gains distribution itself unavailable to help pay the taxes,” the report says.

Morningstar launched the Global Investor Experience study (GIE) in 2009 to encourage a dialogue about global best practices for mutual funds from the perspective of fund shareholders.