When was the last time you saw a mutual fund company introduce a product designed to obliterate the competition with low fees?
A company in the exchange-traded fund business did this just this week. But mutual funds? Never.
What happened in the ETF sector is that a company called Horizons BetaPro issued a new Canadian index-tracking fund with a management fee of 0.07 per cent. That's seven cents per $100 invested.
Pause a moment to absorb what a bargain that is. The next cheapest comparable ETF charges 0.15 per cent. The next cheapest after that costs 0.17 per cent. Big Canadian equity mutual funds charge in the low 2-per-cent range, by comparison.
What were they thinking when they priced the new Horizons BetaPro S&P/TSX 60 Index ETF? Blowing the competition away, that's what.
"We said, let's price this where we can make money, but also where we can potentially discourage competitors from coming in because we've priced at a level where there's no point in trying to compete on price any more," said Howard Atkinson, HBP president.
Bank of Montreal's ETF family has also used low fees to compete. It set the management fee for the BMO Dow Jones Canada Titans 60 Index ETF at 0.15 per cent, a few ticks below the 0.17 per cent for the market-leading iShares S&P/TSX 60 Index Fund.
The BMO Emerging Markets Equity Index ETF has a management fee of 0.54 per cent, while the iShares MSCI Emerging Markets Index Fund charges 0.82 per cent and the Claymore Broad Emerging Markets ETF charges 0.65 per cent.
The outlook for ETF price competition: More of the same. "This is very much a new marketplace, so providers will be seeking market share," said Rajiv Silgardo, head of BMO's ETF operation.
Mr. Silgardo sees limits, though.
"Unless you have a really thought-through business strategy, some of these pricing schemes will probably end up in tears, so to speak. They may not be sustainable."
Cut-throat Competition
We'll see whether HBP can make money with fees so low. A lot will depend on how investors take to the unusual structure of this fund, which replicates the return of the S&P/TSX 60 total return index using complex derivative instruments called swaps instead of holding the actual stocks.
As with ETFs, the cost of owning mutual funds differs from company to company.
"I'd say it's very competitive, pretty cut-throat," said Dennis Yanchus, manager of statistics and research for the Investment Funds Institute of Canada. "Pricing is a major point of competition between firms."
They do hide it well in the marketing of their products, though.
HBP lined up a ton of media attention for the debut of HXT and the resulting coverage focused heavily on the cheap fees. "Invest in ETFs for free - almost," said the headline over Jonathan Chevreau's Financial Post article on HXT.
Mr. Yanchus said the fund industry uses price in its marketing, too.
"I've seen lots of marketing campaigns where one of the features is low fees. But for investors, it's not really just about price. It's about service."
Why ETFs are Cheaper
It's true that mutual fund fees often include a significant portion that is paid by fund companies to investment advisers for serving clients (they're called trailing commissions, or trailers). ETFs don't have trailers embedded, which is an important reason why they're cheaper.
But just as there's price competition between serve-yourself ETFs, why can't full-service mutual funds compete against themselves on the basis of low fees?
This has happened infrequently in the past. Fidelity Investments Canada lowered fees on some of its funds in 2004. CI Investments locked in a portion of its fees a few years ago so they could never go up. RBC Asset Management has issued news releases about fee cuts on particular funds, though I haven't seen one of those in a while.
Lower fees mean lower revenue for fund companies, but those can be offset by higher sales volumes. Plus, the media would eat it up if a big fund firm went rogue on fees.
ETF companies totally get this.
In talking up HXT, Mr. Atkinson estimated that there is a total of $25-billion indexed to the S&P/TSX 60 index at an average fee across the investment industry of 0.14 per cent.
"That's about $35-million in annual fees, and we've just effectively cut that in more than half. There's a lot of dollars on the table that investors can keep in their pocket."
When was the last time you heard a mutual fund company say something like this?
Rob Carrick