It’s time to get over mutual funds’ bad rap

The past year had its scary moments for investors, but on the whole it offered a welcome bout of normalcy.

Canadian stocks offered returns in the higher single digits, and bonds were in the 3-per-cent range. No outsized gains, no big declines. Everything was more or less as it was in the calmer days of yesteryear, except for the mutual fund industry's unchallenged influence with investors.

Done right, mutual funds are a great way for people to invest. Funds are available anywhere financial products are sold, they can accommodate people with small amounts of money to invest, they're ideal for making regular monthly contributions and, ideally, they provide access to smart money managers at reasonable cost. But the fund industry has so lost its way lately that I feel the need to stick up for it.

A lot of people make their investing decisions for the year during registered retirement savings plan season, which ends with the RRSP deadline of March 1. Whether you invest yourself or through an adviser, don't dismiss mutual funds. Their archrival, exchange-traded funds, may or may not suit the kind of investor you are, and picking individual stocks and bonds is hard. Mutual funds are easy compared to the alternatives.

The point of a lot of financial literacy initiatives is that we must smarten people up so they can march ahead to better solutions. For example, investors who understand how stupid-expensive some mutual funds are might choose to open an online brokerage account and start using low-cost exchange-traded funds.

Mutual funds are how we cover off the people who need easy, accessible investing solutions that meet them where they are right now. For example, there are the people who will never open an online brokerage account, no matter how many good things they hear about ETFs.

There was about $850-billion invested in mutual funds at the end of 2012, which means the fund industry utterly dominates retail investing. But funds don't seem to have much momentum these days.

Some Report on Business colleagues and I wrote recently about how retail investors are coming back in force to the stock market (read online here). But in December, a good month for stocks, people sold $1.2-billion more in equity mutual funds than they purchased.

In the heyday of the mutual fund industry, equity fund managers were like hockey stars. Now, it seems as if the equity fund is falling out of favour as a way for investors to get their exposure to the stock market.

The fund industry is still doing okay thanks to brisk sales of bond funds, balanced funds and wrap products, where multiple funds of all types are packaged into a single diversified investment product. Last year, industry assets under management rose 10.4-per-cent over the previous year.

But that's lame in comparison to what ETFs did in 2012. National Bank Financial's analysts say it was a record year for ETFs in which assets jumped 28 per cent to $56.4-billion.

Yes, dramatic sales increases are easier to generate off of a small asset base. But give ETFs credit for consistency – they've been outgrowing funds for years.

The mutual fund industry certainly isn't helping itself connect with investors. Most importantly, it acts like it's oblivious to criticism of its high fees. A major portion of the fees charged by most funds is accounted for by commissions paid to advisers and their firms. Separating this commission from fund fees would help add transparency to what advisers do, and it would make funds cheaper and more directly comparable to ETFs (which don't usually bury adviser compensation in the fee).

The fund industry seems mute on all these topics, so let me speak for it.

Mutual funds, chosen with care, are just the thing for your RRSP. Funds give you every possible investing category in an easily accessible package that comes with varying levels of advice. Also, the fund industry is no monolith. There are high- and low-cost firms, each with a different way of serving investors and advisers.

I'm not all talk on this. In the retirement accounts I look after, there are mutual funds alongside ETFs, individual stocks, bonds and guaranteed investment certificates. I've come to meet some smart people in my job who run mutual funds, and I'm trusting some of my retirement money to them.

The mutual fund industry in Canada is its own worst enemy. But mutual funds themselves are still relevant.

Mutual fund companies: Who's on your side?

Morningstar Canada's stewardship grades are based on how well a mutual fund company's corporate culture, manager incentives and fees are aligned with the interests of its client:

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