The good, the bad, and the shameful: Rob Carrick reviews Canada’s 100 biggest mutual funds

Judge by hype alone and you might think that dividend stocks and exchange-traded funds are all Canadians invest in.

But mutual funds are still the investment of the masses. The data analysis firm Strategic Insight says there was roughly $4.5-trillion in financial wealth in Canada at the end of 2017 – and almost 36 per cent of it was in mutual funds, more than either bank deposits (including guaranteed investment certificates) or individual stocks and bonds.

“In Canada, household assets in mutual funds are significantly higher than in many other jurisdictions,” said Paul Bourque, president and CEO of the Investment Funds Institute of Canada. “For example, Canada is the highest country in the [Organization for Economic Co-operation and Development] in terms of household assets invested in mutual funds.”

Canadians trust mutual funds to help them achieve their investing goals. But how do fund companies repay this loyalty? For answers, we analyzed the 100 largest mutual funds by assets as of Dec. 31, 2017, with a 10-year history at least. With help from Fundata Canada Inc., we looked at their long-term returns, and we looked at how these funds fit into the wave of fee-cutting that the entire investing industry has seen in recent years. We found big funds that really deliver for investors, but also many that do not.

Mr. Bourque sees a good news story for investors in the overall numbers. “In spite of the investing climate and low returns and other challenges that we face, we still have good, respectable returns, for the past 10 years.”

But the numbers also show the investment of the masses is failing its customers in some ways. Fees for the Top 100 have barely moved in the past five years on average, funds with billions of dollars invested in them have delivered weak returns in some cases. And, at the banks that dominate fund sales, there’s a growing trend of streaming clients into “portfolio” funds that often come with hefty fees and underwhelming results.

“I would say the majority of products are not worth investors’ money,” said Dan Hallett, a long-time mutual fund analyst who is now vice-president at HighView Financial Group. “There’s a lot of really mediocre product, and mediocre is kind in some cases. That’s what it comes down to.”

Mutual funds haven’t been a glamour investment since the 1990s, when a strong bull market for stocks helped created a temporary cult of star managers. Criticized at times for high fees and disappointing returns, the fund industry lost some of its brand value in the ensuing years. And yet, the Top 100 funds alone had a colossal $567-billion in assets as of Dec. 31, 2017, or 38 per cent of the industry total.

The importance of mutual funds is magnified by the extent to which they’re relied upon by everyday Canadians to meet financial goals, such as a comfortable retirement. IFIC says investment advisers licensed to sell mutual funds serve 56 per cent of households, or nine million households in total. According to Strategic Insight, the average account size for people who use an adviser licensed to sell mutual funds is $53,181.

“Funds are a way for the average Canadian to participate, in a low-risk, well-managed way, in equity market returns,” Mr. Bourque said. “That’s critical if Canadians are going to save what they need to save for retirement.”

Investing in funds can theoretically reduce risk by providing diversification and professional management. This is the appeal of funds, along with the fact that you can start an account with as little as $100 in some cases and often pay zero in fees or commissions to buy and sell. Also, the fees associated with most funds cover the cost of having an adviser. You can’t analyze fund performance without including this in the conversation.

Table: Rob Carrick evaluates Canada's 100 largest mutual funds Are your funds underperforming? Find out here

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Let’s take a closer look at what the Top 100 can tell us about the job funds are doing as the investment of the everyday Canadian:

Returns

Returns for the particular fund versions shown in the Top 100 were analyzed over the 10 years to Dec. 31, 2017, which is long enough to include strong and weak market conditions. On average, these returns came in 0.85 of a percentage point below the benchmark indexes chosen by Fundata. (Note: Fund firms may use different benchmarks for their products and disagree with the choices made by Fundata.)

On the surface, underperformance by Top 100 funds validates criticism of mutual funds that they chronically lag indexes you can invest in directly at low cost using ETFs. But putting mutual fund and ETF returns side by side is an unfair comparison. Most mutual fund fees include a “trailing commission,” which goes to advisers and dealers who sell funds to cover ongoing service to clients. A mutual fund investing in stocks would typically have a trailing commission equal to one percentage point built into its fee, while a bond fund would be at 0.5 per cent. ETFs usually have no trailing commissions.

Add trailing commissions back to fund returns and you end up very close to the results you’d get from an ETF portfolio. Mr. Hallett said mutual fund managers themselves don’t chronically underperform indexes. It’s only after fees are applied that fund returns lag.

“Investment skill exists – there’s no doubt about that in my mind,” he said. “It’s that retail fees dilute most of that skill. They just eat away at it.”

Trailing commissions – the cost of advice – explain a lot of fund underperformance, but not all of it. Just over half of the Top 100 funds underperformed, over a 10-year period, the benchmark chosen by Fundata by more than one percentage point annualized, which is generally the maximum for trailing commissions. About one-third of the funds underperformed by two percentage points or more. The difference between earning 4 and 6 per cent on a $10,000 investment over 20 years is $10,160 – a total value at the end of $21,911 compared with $32,071.

There are also some funds on the list that flat-out beat their benchmarks, and several of them are Canadian dividend funds offered by big banks like Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia and Bank of Montreal through their branches. Independent fund firms that stand out: Fidelity Investments Canada, with five outperformers among its nine funds on the list, and Mawer Investment Management, which went three for three in having its funds on the list outperform.

RBC Asset Management dominated the Top 100 with 19 funds, a minority of which beat their benchmark. Doug Coulter, president of RBC GAM, said the company’s funds have done very well against comparable passive investments like index-tracking ETFs. “More than 80 per cent of our assets outperformed their passive equivalents in a five-year period,” he said.

Fees

Over the past five years, the investment industry has seen an unprecedented decline in fees of all types. One notable exception is mutual fund fees. The average five-year decline in management expense ratios (MERs) for the fund versions shown in the Top 100 round out to 0.05 of a percentage point, which works out to 50 cents on an investment of $1,000 over a year.

Mr. Hallett said fund companies have recently started to address fees in a limited way. Some have trimmed management fees, which are a component of fund MERs, and some firms now offer cheaper Series D versions of their funds for do-it-yourself investors who don’t need advice.

“It’s only in the past couple of years that we’ve started to see lower-fee fund versions available and cuts in management fees,” he said. “Ten years ago, that was unheard of. They didn’t cut fees because they didn’t have to. Returns were strong and people were buying the products without any fee cuts. There really was no motivation or pressure or anything along those lines to push them to compete on fees.”

Pressure to cut fees is everywhere in the investing industry today. Robo-advisers charge roughly 0.5 of a point to manage a portfolio of low-cost ETFs. Add another 0.25 to the cover the cost of owning ETFs and you end up at 0.75 per cent or less. That’s much less than half the average 1.99-per-cent MER for the Top 100 funds.

There has even been some fee-cutting in the full-service investment advice business. According to a recent report from McKinsey & Co., 30 per cent of advisers lowered prices in 2017 compared with the previous year.

The most intense fee-cutting in the investment industry can be seen in ETFs, which are lower-cost funds that are bought and sold like stocks. The MER for one of the country’s largest bond ETFs, the $2.4-billion iShares Core Canadian Universe Bond Index ETF (XBB-T), has fallen to an estimated 0.11 per cent from 0.33 per cent in 2013. The MER for the $3.7-billion BMO S&P/TSX Capped Composite Index ETF (ZCN-T) has fallen to 0.06 per cent from 0.17 per cent.

Analyst Daniel Straus of National Bank Financial sees fee competition in the ETF business as a reflection of the sector’s relative newness compared with mutual funds. “That deep level of pitched competition for growth, market share and assets is felt far more keenly among ETF participants than mutual fund participants, which are a stodgier, older, more established business,” he said.

IFIC says 28 fund companies cut fees of one kind or another between 2015 and 2017. IFIC’s data on MERs for A-Series funds show an asset-weighted decline of 0.05 of a point between 2013 and 2016 for Canadian equity funds, 0.24 for foreign funds, 0.05 for domestic balanced funds and 0.01 for Canadian bond funds. (Asset-weighted means giving big funds more emphasis than small ones.)

Portfolio funds

Almost one in five of the Top 100 mutual funds are fund-of-fund “portfolio” products that give investors the opportunity to buy a diversified basket of underlying funds with one purchase. The fund arms of the big banks dominate the list in this category, but other companies are players as well. Common to many of these funds are returns that were well short of the benchmarks assigned by Fundata and fees that barely moved in the past five years.

“I’d say that in almost every case, these would not be products I would want friends to invest in,” said Mr. Hallett of HighView Financial Group.

Investor advocate Ken Kivenko marveled at the size of these funds and wondered whether they would be so huge if investment advisers across the country were under an obligation to work to the best interests of clients. Currently, advisers need only decide that a product is suitable for a client.

“If it were on a best-interest standard, these funds would not be able to get to that size,” Mr. Kivenko said.

Portfolio funds are popular because of smart marketing that appeals to unsophisticated investors. The funds are typically labelled along the lines of “conservative,” “balanced,” “growth” and “aggressive growth.” Clients fill out a risk tolerance questionnaire in a bank branch that streams them into one of these categories.

“It’s really easy for the salesperson/relationship manager when they take you through the risk profiler to just match that up to a portfolio that has a very similar, if not identical, label,” said Amelia Young, founder of Upside Consulting Group. “They can say, ‘this portfolio solution has everything you need.’ ”

Ms. Young, who has worked extensively with banks, said these portfolios appeal to investors because they offer instant diversification. “Consumers love the idea of getting a little bit of this and a little bit of that,” she said. “It gives them a lot of comfort.”

Mr. Kivenko says it’s convenience that accounts for all the money in these funds; as of Dec. 31 there was a stunning $55.4-billion in RBC Select Balanced Portfolio and RBC Select Conservative Portfolio combined, which rank first and second in the Top 100 by a huge margin. “People can go into the branch once a year, they get their 45 minutes or an hour [with a planner] and they don’t have to do anything else,” he said. “But to get that hour, you’re spending close to 2 per cent.”

RBC’s Mr. Coulter describes his company as a leader in mutual fund fee-cutting: “Certainly, the majority of our funds are below the industry average.” However, the Select Balanced Portfolio has the same 1.94 per cent MER it had five years ago and the conservative portfolio has fallen just 0.01 of a point to 1.84 per cent.

Mr. Coulter said the fee for these funds includes tactical rebalancing (over- and underweighting sectors to take advantage of market shifts), which has added to returns. Also, investors get access to as many as 29 underlying funds through the RBC portfolios. “We think those [portfolio] funds are appropriately priced,” he said.

Investor takeaways

IFIC says about 85 per cent of mutual fund purchases were made through investment advisers. The substantial number of dud funds in the Top 100 raises questions about how advisers select the funds they recommend to clients.

People who own funds that appear in a bad light in the Top 100 should have a conversation with their adviser about alternatives. For every category of fund in the Top 100, there are both strong and weak options based on returns and commitment to keeping fees reasonable. There are also many smaller funds to consider.

To find quality funds, consider the A+ FundGrade ratings maintained by Fundata. “An A-plus grade means that, within its fund group, a fund has outperformed its peers on a risk-adjusted basis,” said Brian Bridger, Fundata’s vice-president of analytics and data. High risk-adjusted returns mean a fund hasn’t taken on a lot of risk in the securities it holds while generating competitive returns.

Consistency of returns is also factored into the A-plus FundGrades. Some strong Top 100 members that made the grade are: Black Creek Global Leaders, Cambridge Canadian Equity Corporate Class, Compass Conservative Balanced Portfolio, Dynamic Equity Income, Fidelity Canadian Growth Company, Fidelity Canadian Large Cap, Manulife Monthly High Income, Mawer Balanced, Mawer Canadian Equity, Mawer International Equity, RBC North American Value and TD Monthly Income (full disclosure: the author owns the Mawer funds).

Two funds in this list also earned a thumbs up from Mr. Hallett:

-Black Creek Global Leaders: “[Fund manager] Bill Kanko has been lead manager on global equity funds very similar to this one for more than two decades. His record is solid but performance can be streaky for this concentrated global fund.”

-Mawer International Equity: “Mawer is a terrific firm that has long offered quality products at low fees.”

There is also the ETF option if your mutual funds are letting you down. DIY investors have embraced low-cost ETFs, and an increasing number of advisers are using them as well to build all or part of client portfolios. The 2018 Globe and Mail ETF Buyer’s Guide (tgam.ca/ETFguide) can help you get started.