How fat are your funds?
Let's find out using a measure called the Fund Fee Index. It's loosely based on the Body Mass Index, which is widely used to determine whether people are carrying too much body fat. A BMI reading above certain levels suggests excessive weight or, ultimately, obesity. With the Fund Fee Index, high readings warn of weighty fees in mutual funds and exchange-traded funds.
The BMI compares weight to height, which means it puts the body fat issue into some kind of context. The Fund Fee Index does much the same thing by evaluating the fees investors pay to own a fund in relation to the returns they receive.
With the Fund Fee Index, you want the lowest scores you can get for your funds. Consider the most popular exchange-traded fund in Canada, the iShares Cdn LargeCap 60 Index Fund. It has an index score of 0.9, which tells you that just 0.9 per cent of its gross returns over the past five years were clawed back to cover fees. Talk about slim and trim.
Want to know what a well-fed Fund Fee Index score looks like? Then your attention is drawn to the most popular of all mutual funds in Canada, Investors Dividend. The Fund Fee Index score here is 24.8, which tells us that fees ate up almost one-quarter of the gross returns made by this fund over the past five years.
Whether you own ETFs, which are index funds that trade like a stock, or mutual funds, where you benefit from the expertise of a professional money manager, fees must be paid on an ongoing basis. That's fair - the investment industry is a business, not a charitable institution.
Still, it's the responsibility of investors and advisers to make sure that paying fees brings good value in the form of returns. This is where the Fund Fee Index comes in.
It should be noted that the index isn't a straight measure of how much people pay to own mutual funds. For that, you want the management expense ratio, or MER, which measures almost all costs of owning a particular fund as a percentage of its assets. What the Fund Fee Index does show is how a fund's MER compares with its returns, just as the BMI balances your weight against your height. It's all about getting an answer to the question of whether your funds are too weighed down by the fees they charge.
Here are a few quick observations from running Fund Fee Index numbers for some of the country's biggest mutual funds and exchange-traded funds.
1. ETFs are the picture of svelteness in terms of their fees.
2. It's pointless to generalize about the value that investors get for the mutual fund fees they pay - some funds are outstanding, many are middling and some are pretty bad.
3. Dividend funds are one of the better-looking categories, according to the Fund Fee Index, while money market funds are among the worst.
The dominance of ETFs relates to the fact that they mainly hold the same stocks or bonds as a particular index, which means they're easy to run and thus have low fees. Mutual funds, which employ teams of managers and analysts to help identify the right stocks and bonds, cost more to run and thus more to own.
Keep in mind here that the cost of owning both mutual funds and ETFs is invisibly sliced off the top of their gross returns. When you see a published return for either type of fund, it's an after-fee number. If you can't see the fees you're paying, it's hard to judge the value you're receiving.
