More to Funds than Fees: Keep an Eye out for these Attributes

Apart from fees, what considerations should investors keep in mind when picking a fund or ETF? 

Ian Tam, CFA 31 January, 2023 | 4:48AM
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PaletteLet’s not forget: Fees are an important part of buying an ETF or fund.

Fees are a key consideration in buying a fund or ETF because it is the single most consistent detracting factor from an investor’s returns. This is largely because fees are charged regardless of how the fund performs, and the quality of advice that you receive (or don’t receive). On average, Canadians pay roughly 2% in fees for access to a balanced mutual fund. What that means is if the fund returns 8% in a given year, the investor gets 6%. If the fund loses 5%, the investor loses 7%. Over time, this can be significant:

Though it’s true that cheaper isn’t always better, our data, alongside many academic studies point to the fact that based only on fund returns, it doesn’t do the investor any favours to pay more than needed.

This said, investors also need to understand when paying fees is required. For example, if you are in a complex financial situation, need some help in tax or estate planning, or perhaps need some help navigating choppy market conditions, you might seek the help of a licensed advisor. Yes, advisors do charge fees, and often these are bundled with the sale of the funds that you own. We believe that there is distinct value in good advice, whether it be through tax savings or behavioural coaching resulting in better financial outcomes. However, if you don’t find value in these services, it’s probably a good idea to look for an ETF or a D-class mutual fund which strips away these costs.

Alternatively, if you want the advice and help with planning, but don’t want it bundled with your investment, seek the services of a fee-only (also known as advice-only or fee-for-service) financial planner who will charge you a one-time flat fee for advice rather than a recurring annual fee that eats away at your wealth. These advisors typically aren’t affiliated with a bank or product manufacturer and should be unbiased in recommending specific funds.

Fees Aside, What’s Next?
The first thing you want to understand is which asset class you’d like to invest in (stocks, bonds, a combo of both, perhaps others). The more risk you can afford to take on (a function of your age and financial situation), the more stocks (as opposed to bonds) you’ll have in your portfolio. It’s also useful to understand what’s available to you. The 1500 or so ETFs and DIY mutual funds in Canada are split into the following asset classes:

From here, you might dig down further into a specific category. Canadians are privy to a country-wide standard classification system, which includes roughly 60 categories. Here are some of the bigger categories.

Investors should be able to tell what type of asset class (stocks/bonds) and geographical exposure the fund has via the category name, which is maintained by the Canadian Investment Fund Standards Committee. Many fund ratings (like Morningstar’s own star ratings) are calculated against these standardized categories, also known as peer groups.

The Active/Passive Argument
Now that you’ve decided what you want to invest in (stocks, bonds, combo) and where you want to invest (geography), it’s time to decide how you want to invest – more prevalently in the stock sleeve of your portfolio. At the highest level, there are two approaches to stock investing: active and passive. Portfolio managers of actively managed funds have the discretion to make trades in the portfolio that they believe will result in positive gains for the investor. Passive investments on the other hand follow a set of rules, defined by an index rulebook. We write extensively above this topic in our Active/Passive Barometer. Generally speaking, investors who are cost conscious will favor passive management. However, there are arguments in favor of active management for markets that are less transparent, or where financial information is not as readily available (for example in emerging markets like Brazil, China, and India) and the services of a professional portfolio manager is required.  

A third approach is a hybrid between active and passive called ‘smart beta’ or strategic beta. Like passive funds, these products also follow a rulebook. However, instead of targeting a broad market like the S&P/TSX Composite Index does for Canadian stocks, these products target a specific investment style. For example, some smart beta products target dividend-paying stocks, others target value stocks or growth stocks. The good news – these products provide active exposure to a style, at a fraction of the cost of an active manager. The bad news – they follow a set of hard-coded rules, so if the market stops favouring growth stocks for example, the ETF will continue to invest the exact same way regardless of market conditions. Those less familiar with investment factors and styles might opt to stick with a more vanilla passive product instead, at an even lower cost.

There are a few other important attributes of funds to consider, which include whether you decide to go ESG with your investments or leverage active management.

Tomorrow: Thematic, Active-Passive, and Sustainability Factors, as well as Morningstar Ratings to Consider when Buying Funds.

This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before buying or selling any security or investment product.  



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About Author

Ian Tam, CFA  is Investment Specialist at Morningstar Canada. 


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