The Unbundling Of Mutual Fund Fees Continues!

For years now, the fees that mutual fund investors pay, have been primarily integrated fee structures that cover three components:

1.       Investment Management – the fees to the money managers who select the underlying securities

2.       Fund Management – the fees that cover the operation and ongoing management of the fund as an investment vehicle

3.       Service/Trailer Fees – the fees that cover the ongoing advice that Advisors provide to their mutual fund clients

Such fees have been integrated in the offering of Class A mutual fund units for many years (through either a front-end or back-end sales charge option).  In 2000, F Class Funds (Fee Based) removed the embedded Service/Trailer Fee within a Fund and allowed Advisors to include such F Class Funds in Fee Based Accounts at their firm.  Although such accounts have been extremely popular with IIROC member firms, MFDA firms have generally been slower to adopt such fee based accounts.  Additionally, the use of institutionally-priced funds for use in institutional programs such as wrap fund offerings (I or O Class) have become more popular with institutional clients.  Mutual fund companies have begun to position themselves strategically as “money managers” that service both retail and institutional clients as opposed to simply “mutual fund managers”.  The institutional fund units facilitate this positioning because they remove all embedded fees except the fund’s operating costs such as custody, fund accounting & recordkeeping.

However, two recent announcements by Horizons AlphaPro and PH&N highlight the reality that unbundling of the traditional, integrated mutual fund fee structure is continuing in the Canadian marketplace.

First, AlphaPro launched three new actively managed ETFs, which allows investors to get access to “active management” for what effectively works out to be F Class pricing (once you factor in the base fees + anticipated performance fees).  Such F Class pricing has typically only been available to investors who invest with their advisor through Fee Based Accounts, which charge a percentage fee on top of F class expense ratios.  Now this pricing is available through TSX-traded ETFs that now feature some high quality money managers.

Second, PH&N has announced a rebranding of their D Series Fund that offer the Do-It-Yourself (DIY) investors access to DIY pricing that is below that of traditional A Class pricing, with no loads and no transaction fees.  This rebranded offering also includes a suite of online investor profiling and portfolio builder tools.

We believe that the strategic implications for these two announcements are important for the following reasons:

1. Increasing Pressure On Mutual Fund Fees

· These solutions are priced at levels below the traditional fully integrated fee levels of A Class funds by two brand name firms.

· As the pricing strategies/solutions of these two firms “catch on” in the industry, it will lead to increasing pricing pressures on mutual fund companies.

2. Unbundling Traditionally, Integrated Fund Fee Structures To Create Client Alternatives

· Both of these solutions represent are indicative of the growing fee-sensitivity of mutual fund investors when making their own investment decisions.

3. Drive Increasing Fee Transparency

· Given the fact that the currently dominant A Class funds have fully integrated fees that are charged within the overall fund structure, many investors do not really understand how fees are charged within their mutual fund investments.

·  These pricing strategies will drive increased awareness about the various fee structures and levels within mutual funds, which will ultimately lead to increasing transparency of such fee structures.

4. Growing Pressure On Advisors To Create Strong Value Propositions

· As this “fee unbundling” trend continues, we believe that it will force Advisors to establish well-defined value propositions that are “advice based” instead of “transaction based”.    We believe that such advice will need to be portfolio oriented, with a financial goals based mindset.