Two of Canada’s largest investment managers are being threatened with a class-action lawsuit that claims investors were overcharged for actively managed mutual funds that did little more than mimic their benchmark indexes.
Two law firms, Investigation Counsel PC and Bates Barristers PC, filed proposed class-action lawsuits Tuesday in the Supreme Court of British Columbia against TD Asset Management Inc. and RBC Global Asset Management Inc. and its subsidiary, the Royal Trust Co. They target two widely held mutual funds: the RBC Canadian Equity Fund and the TD Canadian Equity Fund.
The proposed class actions allege that excessive fees paid to RBC and TD over many years have significantly reduced the returns of investors.
“Mutual fund trustees and managers are accountable for legal compliance with a set of serious obligations that protect investors from harmful conduct, including excessive fees that deplete fund assets and diminish investor returns” Paul Bates, co-counsel for the plaintiffs, said in a statement.
Both RBC and TD declined to comment on the matter.
The proposed class actions were filed on behalf of RBC investors who held units of the RBC Canadian Equity Fund at any time from June 1, 2005, to present, and TD investors who held units of the TD Canadian Equity Fund at any time from Jan. 1, 2010, to present. The action would still need to be certified by the court; no timetable for a hearing has yet been set. If certified, those investors eligible to join the class action would be notified.
An investor pays a higher fee for a mutual fund than for an index fund on the assumption that they are getting active management that could ideally produce better returns. But some funds have encountered criticism that their holdings are largely the same as what benchmark indexes, such as the S&P/TSX composite index, are comprised of. Such funds have been nicknamed “closet indexers.”
Assets under management for the TD Canadian Equity Fund and RBC Canadian Equity Fund are approximately $5-billion and $2.4-billion, respectively, said John Archibald, a lawyer with Investigation Counsel PC in Toronto, who suggests investors may have overpaid hundreds of millions of dollars in fees over the two periods.
“Canadian mutual fund investors pay among the highest fees in the world and they deserve full disclosure about the manager’s investment strategies and the associated costs,” Mr. Archibald said. “We believe excessive management fees should be paid back to affected investors.”
Management fees on the most common series of these two funds range between 1.6 per cent to 1.85 per cent during the class-action period. In comparison, a passive index-tracking strategy, such as an iShares exchange-traded fund, which tracks the S&P/TSX, charges substantially lower fees between 0.05 per cent to 0.25 per cent.
Dan Hallett, vice-president and principal with HighView Financial Group, says that while he does not have a legal background, as an analyst he would be surprised if the case against the asset managers was successful.
“Depending on the period of measurement, the asset managers may have added value or they might not have, but are you purely looking at raw returns and not at the risk that was involved at achieving those returns?” he said.
Mr. Hallett said there could be a strong argument that having similar returns with less volatility and less risk is a form of “value add” for the investor.
What is known as closet indexing is widespread around the world, and regulators in both North America and Europe have begun to pay closer attention to funds that track the index while charging active management fees.
Canada is one jurisdiction in which the practice has been found to be the most prevalent, according to a paper published in the Journal of Financial Economics by four professors of finance: Martijn Cremers, Miguel Ferreira, Pedro Matos and Laura Starks.
The paper estimates about 37 per cent of the assets in equity mutual funds sold in this country are in closet indexers. By comparison, only 15 per cent of the net assets in equity mutual funds sold in the United States are in closet indexers.
In 2016, the Ontario Securities Commission commenced a targeted review of conventional mutual funds that followed active management strategies. Among other data, the OSC considered the funds’ active share (a measure of the percentage of a fund’s portfolio holdings that differs from the composition of its benchmark index) to assess the extent of active management.
An OSC spokesperson said while the review did not reveal any conclusive findings, nor any items that would merit regulatory action at this time, the commission was continuing to “monitor the issue.”