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portfolio strategy

Exchange-traded fund companies have been slashing their fees lately in a display of macho one-upmanship that you never see in the mutual fund business.

Mutual fund fees are the black hole of Canadian investing. We know from work done by the independent analysis firm Morningstar that our fund fees are among the world's highest. But the fund industry's reluctance to talk about fees makes it hard to tell whether they're falling or not.

So let's dig into the numbers. As a proxy for the fund industry, we'll look at 12 popular mutual funds with combined assets of close to $100-billion. Three of the funds had lower fees in late 2013 than they did five years ago, while nine were charging more.

The past five years were a period when fund companies had to deal with the introduction of the harmonized sales tax in some provinces. A key competitive consideration for the fund industry: Eat the extra costs of the HST, or pass them along? Other business pressures over the past five years included the rise of the ETF sector, which is much smaller than the mutual fund industry but faster growing, and the lingering shock to investor confidence caused by the market crash of 2008-09.

As shown by the group of 12 widely held funds, the overwhelming preference in the fund business over the past five years was to let fees float higher. Where fees did rise, the total increase was typically 0.1 of a percentage point or less. While such increases would have had a modest effect on investor returns, they're still highly symbolic. They suggest that investors should give up on the idea that mutual fund fees in Canada will ever meaningfully decline on an industry-wide basis.

This sort of decline has long been anticipated, in part because our fees are high on a global basis. Fee competition from the ETF business, a direct competitor to mutual funds, would also suggest lower fund costs ahead. The final argument for lower fees is based on economies of scale – the idea that funds become more efficient to run when their fixed costs are applied against rising assets.

On our list of 12 popular funds, there is one that has become significantly cheaper in the past five years. It's Investors Dividend, which went from a management expense ratio (MER) of 2.68 per cent in 2009 for its Series A version to 2.39 per cent in 2013. Investors Group announced a year ago that it was cutting fees to make its comparatively expensive products more competitive, and here is one tangible result.

Fees also declined for Dynamic Strategic Yield and Beutel Goodman Canadian Equity over the past five years, though not so dramatically. The latter fund's decline was notable because the fee was already near the low end for Canadian equity mutual funds.

The nine funds with rising fees over the past five years show a pattern of multiple small increases. The $17.5-billion RBC Canadian Dividend Fund – it's the country's largest mutual fund, according to – has had the MER for its Series A version rise from 1.7 per cent in 2009 to 1.79 per cent in 2013.

A spokesman for RBC Global Asset Management said the rising MER is due entirely to the HST. He also noted that the administration costs built into the MER were cut by 0.02 of a percentage point at the beginning of 2014, while the administration fee for RBC Balanced fell 0.04 of a percentage point. "Overall, over 90 per cent of RBC GAM mutual funds have MERs that are below the category average," he wrote in an e-mail.

It's worth noting that every bank-run mutual fund on the list of 12 popular funds is more expensive to own than it was five years ago. This is admittedly a small sample, but the banks do seem intent on squeezing more fee revenue from their mutual funds.

Rising fees may seem inconsequential for a fund like RBC Canadian Dividend, which has regularly outperformed both the average return for its peers in the Canadian dividend and income equity category and the S&P/TSX composite total return index.

BMO Bond is a different story – returns have been consistently below average over the past five years. Scotia Canadian Dividend made 13 per cent annually for the five years to March 31, while its peers averaged 14 per cent and the index averaged 13.7 per cent.

How common is it for investors to pay fees – maybe even rising fees – for indifferent or worse returns? "Out of all the mutual funds I cover, I would say 25 per cent are pretty decent," said analyst Dave Paterson of D.A. Paterson & Associates. "You've got another 50 per cent that are acceptable, but you might as well be in an ETF, and 25 per cent that probably shouldn't be sold."

ETFs have tiny MERs because they're robotic index-trackers for the most part, whereas mutual funds must bear the cost of analysts and portfolio managers who select individual stocks and bonds. Fund fees also include commissions paid by fund companies to the advisers and dealers who sell their products, whereas ETFs typically do not.

A fair-and-square comparison of ETFs and mutual funds would add a percentage point to ETF fees to cover the cost of investment advice and financial planning that is baked into most fund fees. But thanks to the latest round of fee cuts, you can combine ETFs and fee-based advice and still pay much less than you would with mutual funds.

The iShares S&P/TSX Capped Composite Index ETF (XIC) has an estimated MER of 0.05 per cent today, down from 0.27 per cent a year ago. The iShares people cut the cost of this fund in response to a fee reduction made a while back in a competing product, the BMO S&P/TSX Capped Composite Index ETF (ZCN). BMO's response came this week – a further fee cut in ZCN to match iShares.

The back story here is that ETFs had a disappointing 2013, sales-wise. While global stock markets soared, the flow of money into equity ETFs was offset to some extent by money pouring out of bond ETFs. Add a growing number of competing ETF providers to this picture and you end up with recent fee cuts announced by iShares and BMO.

The mutual fund industry had quite a decent year in 2013 and now sits on roughly $1-trillion in assets, compared to $66-billion for ETFs. Do not expect a mutual fund fee war any time soon.

Follow me on Twitter: @rcarrick

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