Canada pins its hopes on mutual fund transparency

Deborah Fuhr

Canada has earned itself a reputation as an innovator in the exchange-traded fund world: on March 9, 1990, the Toronto 35 Index Participation fund became the world’s first ETF when it listed on the Toronto Stock Exchange, and since then the country has delivered many other firsts, including introducing the first fixed-income, currency-hedged, adviser-share classes and non-transparent active ETFs.

However, despite 24 years of education and innovation, Canada’s image as an ETF leader appears somewhat tarnished. Last week at the Radius Exchange Traded Forum in Toronto, investment professionals expressed concern over the decline in the rate of growth in assets invested in Canada-listed ETFs and the slow adoption by financial advisers who prefer to be paid to sell mutual funds. Forum delegates were hopeful that regulatory reforms requiring transparency on mutual fund costs will encourage more advisers to consider ETFs.

The country is home to 299 ETFs worth $59 billion from 10 providers. Last year, their assets increased by just 5%, in stark contrast to the 28.5% rise for US-listed ETFs. Investments in ETFs as a proportion of the mutual fund industry declined from 6.6% to 6.4% while their US counterparts grew from 9.3% to 10.3%. The decline in ETF assets has surprised many people since poor performance and high fees from mutual funds have been disappointing, which could have been beneficial to the ETF industry.

Canada is ranked among the most expensive countries for mutual fund fees with a median average management expense ratio of 2%, compared with an asset weighted average total expense ratio of 0.4% for ETFs. It has also been shown that few active mutual funds consistently deliver alpha.

The Spiva Scorecard, which compares fund manager results, shows that in 2012 only 15.39% of Canadian equity mutual funds outperformed the TSX Composite index over three years, and over five years it is an even lower 10.35%.

Delegates at the Toronto forum cited a Morningstar report which compared the total expenses of funds in 22 countries and graded Canada a fail for “fees and expenses”. The study found that fees in the country are the highest for equity and third-highest for fixed-income funds.

Mutual funds have been part of the investment landscape for 82 years and more than 60% of Canadians with a savings or investment account use them.

Most mutual fund sales are conducted through advisers. Investors incur two types of costs when buying and owning a fund: sales charges when investors buy or sell a fund and management fees and fund expenses which are deducted from the fund assets and typically include an embedded ongoing trailing commission of 1% to the adviser.

Over the past few years the UK, Australia and The Netherlands have introduced regulations changing the way retail investors buy funds by banning adviser commissions and regulating how they pay for financial advice.

Efforts by the Canadian Securities Administrators, an umbrella body of regulators, have been more muted. The CSA’s investigation into mutual fund fees have focused on transparency and on July 15 rules will kick in requiring fund providers to help investors better understand the costs, performance and adviser compensation associated with mutual funds.

The ETF industry hopes that as investors begin to understand the impact higher costs and fees have on investment performance, they and their advisers will look at alternatives such as equity, fixed income and smart beta ETFs.

http://www.efinancialnews.com/story/2014-04-14/canada-pins-its-hopes-on-mutual-fund-transparency