By: Larry MacDonald
Oh my! Mackenzie Financial, the biggest mutual-fund family in Canada, has fired a broadside at exchange-traded funds (ETFs). Financial columnists Ellen Roseman and Jon Chevreau have recently commented on the critique, which can be found on the Mackenzie Financial website under the title ‘I thought I wanted an ETF.’ Here are some thoughts inspired by the piece.
Cost of advice embedded in mutual funds:
The mutual fund vs. ETF debate often overlooks the fact – as the MacKenzie Financial piece points out (and I have too) — that the cost of most mutual funds contains the cost of financial advice (i.e. trailer fees paid to financial advisors), so comparing the costs of ETFs to mutual funds is comparing apples to oranges. Fair enough. But are investors getting service commensurate to the fees? And, do advisers put their clients in the best funds or the funds that pay the best trailer fees?
• A survey sponsored by the Financial Planners Standards Council (FPSC) showed only 40% of certified financial planners did financial plans for “most” of their clients in 2006, down from 53% in 2002
• At least five studies from the academic community conclude financial advisers don’t add value to the selection of mutual funds – indeed, it appears they subtract value (a grey area is ancillary services like tax and estate planning)
Portfolio turnover costs and sales loads:
The mutual fund vs. ETF debate often focuses just on MERs and commissions to buy or sell ETFs – as MacKenzie Financial does. Other expenses to consider are portfolio turnover costs and front- or rear-end sales loads. The latter can add another 1.5% to the average annual MER of 2.5% in Canada for an equity mutual fund, bringing the total “all-in” annual cost to 4%
• John Bogle in The Little Book of Common Sense Investing estimates the cost of portfolio turnover of the average equity mutual fund adds 1% in annual costs (cost of broker fees, bid-ask spreads, and market impact costs)
• Front- or rear-end loads can add up to 5% to costs, which for a 10-year holding period, averages out to 0.5% annually (to use John Bogle’s figure); ETFs do have brokerage fees but for order sizes over $3,000, they generally average less than 1% to buy or sell
Bond and money market funds:
The mutual fund vs. ETF debate often just focuses on stocks funds – and so does the MacKenzie Financial article. There are also money market and bond funds. And they are “where mutual funds fees really hurt,” as Rob Carrick says in his book, How to Pay Less and Keep More for Yourself. Money market funds charge MERs that average half or more the interest earned, while bond funds MERs average close to 1.5% when yields currently range 2% to 4.5%. One could also add balanced mutual funds. In non-equity funds, the comparison of long run returns more clearly favor ETFs.
Heterogeneity in product classes and investors:
The mutual-fund vs. ETF debate tends to overlook the high level of heterogeneity in product classes and investors
• Not all ETFs are good — for example, sector and leveraged ETFs may raise questions.
• Not all mutual funds are bad – for example, mutual-fund families without marketing and advertising overheads can keep MERs low while providing advice through in-house reps; other useful mutual fund categories may be corporate class (tax advantages) and F-class (no trailer fees); closet-indexing mutual funds would definitely not be on the good list.
• Since mutual funds reinvest dividends and allow regular deposits without commissions, they could be more cost effective for the small investor with regular, small amounts to contribute
• Some investors don’t have the time or desire to manage their personal finances so would be not be deterred by extra costs
To be continued ….
7 Responses to “ “I thought I wanted a mutual fund” ”
The comparison of fees was pretty suspect. With ETFs, if you’re really paying (an exorbitant) $24/trade, you can just batch them up, and make purchases every quarter. That’s a three-fold reduction in fees even without changing brokers.
As for paying for advice, I don’t mind paying for service. I would resent paying for advice I don’t use.
The worst part is the bald-faced lie that long-term mutual fund investors have outperformed the indexes. Obviously this would be due to survivorship bias. As “evidence” they present three carefully-chosen funds that have outperformed over the last ten years. What they don’t tell you is how you could have known that ten years ago.
By Patrick on Oct 20, 2009
Patrick
Thanks. I’ll be mentioning these points as well in part 2 of my post, coming later today.
By Larry MacDonald on Oct 20, 2009
Question
Why is there such a disparity between the net real returns of 8-9% produced by our Mutual Fund Winners Spreadsheet (MFWS) since 1994 compared to the average investor’s net real returns of 1-2% after fees, expenses, taxes and inflation?
Rather than bemoan this sad state of affairs and since it is unrealistic to expect expenses, taxes and inflation to be drastically reduced any time soon, the approach was to find out what controllable factor(s) are responsible for this drag on performance.
Since fees are controllable, the MFWS is confined only to no-load, no fee funds. These funds incur only inside management fees averaging only a .5% to acquisition costs rather than 2-3% giving the fund investor an initial, but limited, boost in returns.
While this is good news the objective should be to boost net real returns from the current 1-2% to 8-9%. This seems incredulous only because we have been looking at the wrong explanations while discarding the right explanations for the last 5+ decades.
After 15 years of research using over 200+ million data cells and some luck, we found the culprit. It was “adverse selection”, which is the systematic selection of more losers than winners usually on a 75:25 ratio basis. By reversing these odds, mathematically, many times more winners than losers are now easily and consistently picked.
A winner is defined as a fund whose performance consistently outperforms the Standard & Poor’s 500 Stock Index over time. A loser is defined as a fund whose performance consistently under performs the Standard & Poor’s 500 Stock Index over time.
The MFWS was designed in 1994 to enable investors,brokers,dealers,advisers… to pick winners by overcome adverse selection and to provide investors with advice in interpreting a science-based, financial independence road map.
By Arthur Regen on Nov 21, 2009