All about loads, fees, commissions, and MERs
When it comes to investment funds, fees and costs can be both complicated and contentious. What’s the difference between an MER and a front-end load? Are fund commissions deductible? What are trailer fees? To help clear up some of the fog, here’s a rundown of how fees and costs are applied in the world of investment funds.
Management Expense Ratio (MER)
This is the one everyone quotes and everyone looks at – and, of course, about which there’s much complaining among fund “activists.”
The MER is the sum total of all operating expenses and management fees paid by an investment fund expressed as a percentage of the fund’s assets. Management fees are charged to the fund by the fund’s managers, while the fund pays operating expenses such as legal and accounting costs, custodial fees, and other administrative expenses. The total of all these fees and costs is known as the MER.
MERs vary from fund to fund, ranging from as low as 0.10% (one tenth of one percent) for some passive index-tracking mutual funds to over 5% for some types of segregated funds. Generally, funds with more complicated or more active management have higher MERs, because the managers do more research or trade more actively (which raises transaction costs) in search of better performance, and so on. Funds with guarantees (like segregated funds) have higher MERs, because of the cost of the insurance premium.
Exchange-traded funds (ETFs) tend to have lower MERs than mutual funds. Management fees and operating expenses are kept to a minimum because most ETFs passively track an index of some kind, so there’s no need to pay a fund manager to incur expenses in researching and trading securities. ETFs that track so-called active indexes generally have higher MERs relative to true passive ETFs owing to higher transaction and other costs incurred when changes are made to the underlying index.
Investors do not pay the MER directly. Rather, it is deducted directly from the assets of the fund, in effect reducing the fund’s return, and ultimately your return. A high MER is a serious hurdle for both managers and investors, so it’s crucial to look at a fund’s performance data in conjunction with its MER before investing. Is the fund actually delivering long-term performance that warrants a high MER? It’s simple: If it isn’t, don’t invest.
Note, though, that a low MER doesn’t translate automatically into better returns. A fund with an 8% return and a 2% MER still delivers a better return than a fund generating a 4% return with a 1% MER.
This is another bone of contention for many fund activists, who see it as a nefarious plot to milk the hapless investor of even more capital. Unfortunately, in some cases, this is exactly what has happened, especially where the existence of a trailing commission has not been disclosed.
Essentially, a trailing commission, or trailer fee, is a fee paid by the fund management company (from its own management fees, and thus is part of the MER of the fund) to the advisor or mutual fund dealer from whom you purchased the fund, as compensation for investment and financial planning services. Critics argue that trailer fees are simply incentives paid by fund companies to get advisors to push their product.
If you’re buying a fund through a dealer or registered advisor, ask them whether they receive a trailer fee and how much it is. If you’re uncomfortable with such an arrangement, the solution is again quite simple: don’t invest.
Sales charges, or loads
A sales charge, often referred to as a “load,” is the commission you sometimes pay directly to a fund dealer or brokerage firm for buying or selling a fund. When you are required to pay a commission at the time you purchase units of a fund, it’s called a “front-end load.” This is often negotiable depending on the advisor you deal with. If you pay the commission when you sell, it’s called a “deferred sales charge” (DSC), and is not negotiable – in fact, a DSC can lock you into a fund for a few years, and there are usually steep penalties for withdrawing before the DSC expiry date. A load of any kind eats into your return, because you pay it directly from your investment. Mutual funds can often also be purchased without a sales charge, or on a “no load” basis.
Because ETFs are traded on an exchange like stocks, you’ll pay a trading commission to your broker when you buy and when you sell.
A fund’s MER is listed on its fact sheet, available through the fund company or on its website. Fund Library also lists MERs and load options for all funds in its database, and provides a convenient way to compare MERs and performance across a wide variety of funds and time frames.
Trading commissions, loads, fees, and MERs are not deductible expenses for investment funds within registered accounts like RRSPs. In non-registered accounts, some trading and advisory fees and expenses may be deductible in certain circumstances (but not MERs). Check with a Certified Financial Planner or a qualified tax expert to determine whether any of your investing costs are tax-deductible.
© 2015 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.