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Canadians are overcharged by mutual funds, study says

Date: Monday, August 28, 2006
Author: David Clarke, InvestmentNews.com

OTTAWA - Canadians are being ripped off by mutual fund providers, according to a recent study.

Although Canada and the United States are alike in many ways, "their mutual fund fees differ dramatically," according to the study, "Mutual Fund Fees Around the World," written by Ajay Khorana, Henri Servaes and Peter Tufano.

"We can see that after controlling for fund type, fund size, complex size and other variables, the [United States] is among the lowest-fee countries (by fund registration) in our sample, and Canada is the single-highest-fee country by far."

Mr. Khorana is the Wachovia Associate Professor of Finance at the Georgia Institute of Technology in Atlanta.

Mr. Servaes is a professor of finance at the London Business School.

Mr. Tufano is the Sylvan C. Coleman Professor of Financial Management and senior associate dean at the Harvard Business School in Boston.

Bank distribution a factor

"The U.S. fixed effect is [0.85 percentage] points, but the Canadian fixed effect is [2.08 percentage] points, which is 145% higher Mean management fees for equity funds are [0.79 percentage] points in the [United States], versus [2.11 percentage] points in Canada; corresponding mean total expense ratios are [1.71] and [2.87 percentage] points, respectively," the authors wrote.

Why the difference?

"In private discussions with practitioners, various explanations have been advanced for these differences: Canada's fund industry is small and is dominated by bank distribution in a relatively concentrated banking sector. The percentage of banking assets controlled by the five largest banks is 84% in Canada but only 20%" in the United States, according to the study, which has led to spirited debate in Canada.

Jonathan Chevrau, a columnist for the Toronto-based Financial Post, covered the study, and he wrote in a column that he received a fax blasting him for providing "inaccurate and confusing information regarding such an important topic" from Brenda Vance, president of RBC Asset Management Inc., part of Toronto-based RBC Financial Group.

Like other banks, RBC is a key player in the mutual fund business. RBC Asset Management is one of Canada's largest money managers, with more than $52 billion ($C58 billion) in the RBC funds group.

In her fax, Ms. Vance pointed to another study, by Investor Economics of Toronto, which said that management expense ratios of average load funds sold in Canada were 2.47% in 2004, while the ratios for no-load funds such as those sold by the banks were 1.7%.

But the Investor Economics study is from 1995, and the present one is backed by Chicago-based Morningstar Inc. data, "so the debate is not whether Canada's [management expense ratios] are higher, only how much higher they are than everywhere else," Mr. Chevrau wrote in a column.

"I think Americans are more aggressive in general, including their investment activities. It's a matter of choice," said Dan Hallett, president of an eponymous Windsor, Ontario-based investment research firm that specializes in managed-money products.

Long holding periods

"Many articles report the U.S. mutual fund investor's holding period at about three years for stock funds," he said. "I can't say that I really know what's behind that figure, but I can tell you that Canadian mutual fund investors hold their equity funds - and most other non-money-market funds - for six to seven years, depending on when you take the measurement."

In the Financial Webring Forum, a blogster who calls himself NormR wrote: "I note that several low-fee fund families have set up shop in Canada, only to fail. This is the result of the uneducated masses that either cannot or choose not to think for themselves ... and merely react to their full-service broker's recommendations or react to who is selling the most advertising - a sad reflection of Canadian financial acumen."

In the study, the authors pointed to the importance of investor protection.

"Using a new database, we study fees charged by 46,799 mutual funds offered for sale in 18 countries, which together account for about 86% of the world fund industry," they wrote.

"We examine management fees, total expense ratios and estimated total shareholding costs (which include load charges). Fees vary substantially from country to country."