Dan Hallett is director of asset management for Oakville, Ont.-based HighView Asset Management Inc.
The investment industry is slowly coming around to the notion that fees matter. Investors should always keep an eye on costs - just not to the point where it drives investment decisions. Whether you pay mutual fund management expense ratios (MERs), a wrap account fee or some other annual fee, here are three tips to help you keep the importance of fees in perspective.
Importance of fees varies by type of investment
An investment's cost is the only factor with a known, certain impact on future returns. Its importance in the context of judging a particular fund or investment, however, varies. Fees should be a dominant factor, for instance, when selecting very conservative mutual funds (such as money market, bond and bond-heavy balanced funds). With the Canadian bond market (represented by the DEX Universe Bond Index) sporting a yield-to-maturity just north of 3 per cent, fees are more important than ever.
Fees are less important when selecting more growth-oriented offerings, like stock funds. But less important doesn't mean unimportant. While I wouldn't advise choosing a stock fund based solely on its fee, this should be a selection criterion since long-term out-performers tend to have below-average fees.
Every manager has a limit to what he or she is worth
Bill Miller has been lead manager of the U.S. value portfolios for Legg Mason Capital Management for about 20 years. Despite a recent three-year slump, Mr. Miller has outperformed the S&P/Citigroup U.S. Broad Market Index by more than two percentage points annually, before fees, over the past 20 years. Many readers will be familiar with Mr. Miller's once-famous streak.
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Investor Education on mutual funds:
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Calendar year 2005 marked the 15th-consecutive year in which his portfolio outpaced the index.
Mr. Miller himself tried to play down the streak, noting that it would never have approached 15 years if measured on a basis other than calendar year. But I know that his funds have been sold in part on the back of this streak, which Mr. Miller himself called a statistical fluke.
The version of Mr. Miller's fund that is sold to U.S. investors boasts fees below 1 per cent annually. CI has been selling a version to Canadians - CI Value Trust Corporate Class - since 2001 which charges 2.58 per cent per year. For fun, I took Mr. Miller's record as lead manager with zero fees and looked at how his longer-term record held up when applying the 2.58 per cent fee charged by CI. After deducting the 2.58 per cent per annum, the famous 15-year streak would have been 40 per cent shorter; a still-impressive nine calendar years (1995 through 2003). Since Mr. Miller himself saw little importance in that particular streak, let's look at how his broader out-performance history would have differed if CI's fee structure had applied throughout the entire period studied.
Eagle-eyed readers will notice that the 2.58 per cent annual fee difference is less than the 2.80 per cent per year performance erosion. The erosion is due to the impact of compounding. Impressively, however, Mr. Miller's longer-term out-performance over rolling five- and 10-year periods in the tough-to-beat U.S. stock market would have remained strong. I believe that Mr. Miller's under-performance in recent years was indeed a slump and not proof that he lacks skill. But the point of this illustration is that investors shouldn't ignore costs when faced with someone who is considered a star manager.
Impact of fees compounds over time
Fees make an impact on daily, weekly, and monthly returns. But the drag caused by fees is not obvious over such short time-frames. As those days, weeks, and months compound out into longer periods, fees become more visible. And the longer the time period, the bigger the compounding effect. This is the reason why the list of shorter-term out-performers often includes high-fee funds, but top performers over longer periods usually have below-average fees.
BILL MILLER V. S&P/CITI U.S. BROAD MARKET INDEX
Jan. 1, 1990 through Dec. 31, 2009
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Fees |
0.00% MER |
2.58% MER |
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Annualized Returns In Excess of Index |
+2.19% |
-0.61% |
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Frequency of outperformance... |
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...over rolling 10-year periods |
87% |
80% |
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...over rolling 5-year periods |
85% |
71% |
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...over rolling 1-year periods |
66% |
55% |
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...on a monthly basis |
56% |
52% |
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Sources: eVestment Alliance, S&P/Citigroup |
Dan Hallett