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Are fees included in my fund’s returns?

When fund companies advertise their returns, are the numbers before – or after – fees and expenses?

Performance data published by mutual funds and exchange-traded funds are after deducting the management expense ratio (MER), which includes the fund's management fee, operating expenses and taxes. That's only fair, considering these costs directly affect the investor's return.

The MER is expressed as a percentage of the fund's average assets for the year. However, instead of being subtracted annually in one shot, the MER is usually deducted on a daily (prorated) basis and is reflected in the net asset value of the fund. Fund returns are also reported after trading costs, which are reflected in the trading expense ratio (TER).

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For example, if the underlying portfolio in a mutual fund posted a total return of 10 per cent during the year and the MER and TER totalled 2 per cent, the investor's net return would be 8 per cent.

Another thing to keep in mind is that mutual fund and ETF performance numbers reflect the total return – that is, they include both capital appreciation and income from dividends and interest. Further, it's assumed all distributions were reinvested in additional units. If you're looking at published returns for a particular fund, it's important to pay attention to the specific series (denoted by a letter such as A, I, D or F after the fund name). Different series have different MERs and, hence, different returns.

Dan Hallett, vice-president with HighView Financial Group, said fund companies often highlight returns of their F-series funds, which are used in fee-based adviser accounts and typically have the lowest MERs. However, this is misleading because "no investors can just buy the F-series fund being advertised 'as is' like they can an ETF. You can only buy the F-series by paying an extra percentage fee to your adviser – 1 per cent or so plus tax for most people," Mr. Hallett said.

What about taxes? If you hold a fund in a non-registered account, taxes will certainly affect your net return. However, because people's tax situations vary and many individuals hold funds in a registered account, fund returns are reported on a pretax basis.

While looking through my T3 tax slips for 2016, I noticed that in one case – the Voya Floating Rate Senior Loan Fund (ISL.UN) – the capital gain reported on my T3 far exceeds the cash distribution I received. How do I report this for tax purposes?

Investment funds – including mutual funds, exchange-traded funds and closed-end funds such as ISL.UN – sometimes reinvest all or a portion of their capital gains internally instead of paying them out to unitholders. Even though you never actually receive these reinvested or "phantom" distributions as cash, you still have to pay tax on them as if you did. Reporting capital gains for tax purposes is straightforward. The total of a fund's capital gains – both reinvested and distributed in cash – is included in box 21 of your T3, and you would record this amount on your tax return.

However, when a fund has a reinvested distribution – as ISL.UN did last year – you need to do one more thing: Increase the adjusted cost base (ACB) of your investment by the amount of the reinvested distribution. Otherwise, you will end up paying more tax than necessary when you ultimately sell your units.

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Identifying a reinvested distribution sometimes requires a bit of digging. If you go to ISL.UN's website, click on "Distributions & Tax Info" and look under "2016 tax information," you'll see that in June the fund had a capital gain of 76.75 cents and foreign non-business income of 16.06 cents, for a total distribution of 92.81 cents. However, only 26.33 cents of this was actually paid to unitholders in cash, while the remaining 66.48 cents was a "non cash distribution" that was reinvested in the fund. To understand how this affects your ACB, think of the reinvested distribution as a two-step process: You receive the distribution (on which you must pay tax) and then the distribution is immediately plowed back into the fund. It's effectively the same as if you received the distribution in cash, paid the tax, and then reinvested the money yourself. In both cases, you are effectively putting new money to work, so you need to increase your ACB by the amount of the reinvested distribution per unit (multiplied by the number of units owned). By increasing your ACB, you will reduce your capital gain (or increase your capital loss) when you sell your units down the road.

If you're wondering where ISL.UN's large capital gain came from, Kal Zakarneh, vice-president, finance with the fund's manager, LOGiQ Asset Management, said it related to the termination of a forward agreement that the fund previously used to "recharacterize" taxable income into tax-deferred return of capital. The federal government ended such conversions in 2013, but funds with long-term forward agreements in place were given several years to comply.

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About the Author
Investment Reporter and Columnist

John Heinzl has been writing about business and investing since 1990. A native of Hamilton, he earned a master's degree from the University of Western Ontario's Graduate School of Journalism and completed the Canadian Securities Course with honours. More

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