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INVESTMENT PERFORMANCE AND COSTS OF PENSION AND OTHER RETIREMENT SAVINGS FUNDS IN CANADA: IMPLICATIONS ON WEALTH ACCUMULATION AND RETIREMENT
By Dr. Vijay Jog December 2, 2009
TABLE OF CONTENTS
Summary Background Scope and Context The Investment Landscape Existing Research-Based Evidence: Investment Returns and Performance Canadian Investment Landscape Investment Landscape: Costs and Returns Implications of the Investment Cost Structure on Retirement Income Adequacy Overall Key Observations and Conclusions References Appendix A: Glossary of Terms Mutual Funds
SUMMARY
This paper presents an analysis of the potential impact of investment returns on the retirement income adequacy of Canadians. Rather than solely looking at whether Canadians are saving enough, Jog argues that there should be equal emphasis (if not more) placed on how as Canadians we can make smarter investment choices. Accordingly, the paper attempts to document empirically the interaction between investment choices, cost of investments, investment returns and retirement income and wealth. The first section of this paper looks at existing research-based evidence on investment returns and performance through the performance of individual investors, mutual funds and other professionally managed savings. The key message from this section is that individual investors typically make poor decisions and while professionally managed funds outperform passive strategies, the investor incurs costs that are not compensated by returns. In the second section, Jog looks at the Canadian investment landscape by focussing on the experience of a hypothetical Canadian individual using data over the last twenty five years. The date shows that: 1) maximising savings through an RRSP makes a significant difference depending on the investment vehicle chosen and the tax rate faced by the individual at retirement; 2) the choice of investment matters; 3) even after saving 18% of salary each year for 25 years, the end period wealth can only sustain the individual for twenty years or less; and 4) being a regular and an early saver matters. The third section looks at the costs and returns in the investment landscape. The conclusions drawn from this section are that a "do-it-yourself" investor can invest at a relatively low cost though it is still somewhat higher than the cost of investing through a private sector defined benefit plan with the costs of investing with a financial advisor being the highest. The forth section examines the implications of the investment cost structure on Retirement Income Adequacy. Table 15 looks at assumptions on cost and the impact on retirement income and notes that using a portfolio with both advice and active management that earns the same rate of return as the underlying index would result in a loss of 4 years of wealth. Table 16 estimates overall costs of the entire pension system. The paper concludes by highlighting 7 overall key observations: 1) retirement income adequacy depends on tax assistance for savings (RRSP); 2) skipping years of saving or starting late has a significant implication on wealth accumulation; 3) investments of pension assets were worth $2.1 trillion as of 2007; 4) these pension assets are invested in a variety of securities (including 30% in foreign securities); 5) a high proportion (55%) is invested through employer sponsored plans (90% are defined benefit) ; 6) active management, over the long-run, does not add incremental value over a passive index and finally; 7) using 2007 data, the estimated overall cost of investment is 78 bps per retirement assets totalling
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
$17.7 billion for $2.1 trillion of total assets. Of that $17.7 billion, the costs associated with investment advice, administration and active management account for $9.3 billion, almost 50% of the total costs. Acknowledgements: This paper is written for the Research Working Group on Retirement Income Adequacy. I would like to thank many people for providing input, data and comments including: Kim Duxbury of Sunlife Financials, Blake Hill of Manulife Financial; Louis-Georges Mongeau of Standard Life of Canada; Terrie Miller of CEM Benchmarking Inc.; Keith Ambachtsheer of KPA Advisory Services Ltd.; Dennis Yanchus of Investment Funds Institute of Canada; Ronald Sanderson of Canadian Life and Health Insurance Association of Canada; Alfred LeB lanc of Department of Finance, Government of Canada; Christopher Donnelly and Paul Bean of RBC Asset Management Inc.; Jack Mintz, University of Calgary; Suzanne Paquette, Universit Laval; and many others who also commented on the paper. I would also like to thank Mariela Wong, Ruben Palencia and Patricia Robertson for providing expert research assistance under very tight deadlines.
BACKGROUND
Retirement income adequacy of Canadians depends upon a variety of sources of income. However, five of these seem be the most important. First is the income support provided by the government through broad based programs such as OAS/GIS and CPP/QPP. Second is the employer (public and private sector) sponsored defined benefit (DB) pension plan where an employer is contractually obligated to provide benefits based on years of service and salary. The third source is the employer-sponsored defined contribution (DC) plan where both employer and employee contribute to a fund and the retirement income depends on the investment performance of the fund. The fourth source is the individual tax preferred savings vehicles such as RRSPs (including group RRSPs) and TFSAs. The main difference between the RRSP and TFSA is that the contribution made in the former (RRSP) investment vehicle gets a tax deduction at the time of contribution but is taxed when the funds are withdrawn, whereas with the latter (TFSA) it is the reverse. The fifth source is income that can be earned on assets accumulated outside these four sources, namely, non tax assisted savings and other real assets such as home and cottage and business assets. Each of these five sources/components is associated with different levels of risks and costs. The first source is probably the least risky while the risk of the second component is employer bankruptcy along with a high unfunded pension plan (e.g., Nortel or GM Canada). The risk of the other three sources comes from investment choices, rates of returns and costs associated with the investment vehicles being used. Thus, retirement income adequacy depends not only on the various types of savings vehicles and the timing and amount of savings, but also on the investment choices and returns at least on those investments which are not guaranteed by the government or the employer. It is also important to note that, except for public sector plans, the risk of employer bankruptcy with an underfunded DB plan is nontrivial since, in many cases, this is the time when DB plans also become severely underfunded due to a decline in the market value of the pension fund. The intent of this paper is to focus on the investment component (as opposed to the savings component) of the retirement income debate and its implication on retirement income adequacy. More specifically, the paper focuses on expanding our overall understanding of the investment choices available to a Canadian resident and investment performance of various savings and investment vehicles and intermediaries who assist in channelling individual savings so that they can provide adequate post retirement income to individuals.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
(e.g., DB or DC plans and managed mutual funds). In essence, there are three ways to accumulate wealth for post-retirement years: personal decisions (RRSP), through DB, DC or group RRSP plans, or through an intermediary that provides both advisory and investment options. In each case, the ultimate investment can be in an individual security (e.g., common stock or bond) or a passive index (either an Exchange Traded Fund (ETF) or an Index fund) or an actively managed (and recommended by a financial advisor) mutual fund or a segregated fund with or without an insurance guarantee. In all cases, the ultimate choice can be based on a "do-it-yourself" process or through a financial advisor. 1 In addition, the assets underlying the DB and DC plans are being invested by pension fund managers and insurance companies on behalf of investors and employers. Moreover, a portion of CPP assets are now being invested by the CPP Investment Board. It is also clear that these different choices and vehicles would be associated with differences in costs and rates of returns. The typical assumption would be that, on average, an individual expects to be better off with his investment choice when the costs incurred to undertake an investment are more than offset by a higher risk-adjusted return. Accordingly, the main objective of the paper is to document empirically this interaction between the investment choices, cost of investments and investment returns. Our review includes a broad range of choices and investment vehicles to provide a better understanding of costs (historical and current) and risk adjusted returns. We also provide a perspective on existing research evidence on various issues associated with this trade-off. With respect to empirical evidence on historical rates of return and costs, we investigate the following vehicles/assets: Direct assets: T-bills, bonds and common stocks Indirect assets: Exchange Traded Funds (ETF), Index funds (passive), active (professionally managed) funds (by mutual fund companies, banks), segregated funds managed by Insurance companies (available for group RRSPs and DC plans 2 Professional indirect vehicles: Pension funds (DB) and the CPP Investment Board In addition, wherever the data permit, we investigate and document gross and net returns with appropriate benchmarks, differences between public and private sector plans, possible rationale for costs and differences between gross and net returns, economies of scale and scope aspects that have direct implications on our understanding of the influence of investment choices on retirement income adequacy. Our data comes from a variety of diverse sources including CANSIM, Statistics Canada, Sedar, CEM Benchmarking Inc. (for pension funds), IFIC (for mutual funds), CLHIA (for segregated funds) and other publicly available sources. We are aware that the diversity of sources may pose a challenge in cross comparisons; we do our best to ensure that a clearer picture emerges from our analysis with appropriate caveats.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
response to investor demand. As far as we know, there is no direct evidence ( la Barber and Odeon) on the investment performance of Canadian retail investors. The research analysing flow of funds into Canadian mutual funds (Deaves, 2004; Sinha and Jog, 2005) concludes that, unlike the U.S. investor, Canadian investors do not invest disproportionately in winning funds, and they do seem to punish losing funds. They claim that past performance and past asset allocations, as well as fund size and the size of the fund family are significant determinants of current fund flows and Canadians are more forgiving of losing funds.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
outperform the benchmark which is significant both statistically and economically. Second, a significant majority of the IAMs use performance-based fee structures, quite unlike the mutual fund fee structure where MERs are independent of performance which may lead to reduced agency costs. Third, and more significantly, there is a significant inflow of new funds into high performing (first quartile) asset managers whose performance declines due to this high influx of funds. As a result, they state that "however, the persistence that is the source of potential gains for plan sponsors is its very own death knell: we find that portfolios in the winner deciles draw an in?ux of capital from plan sponsors, and in the year following this capital in?ow, the excess returns disappear." These results of outperformance found by Busse et al. are, however, in contrast to some earlier papers such as Lakonishok et al. (1992) and Coggin, et al. (1993) who find that performance is poor on average, investment managers have limited skill in selecting stocks, and Survival bias and a short time series does not allow for a robust conclusion about persistence.8 The Bauer and Frehen (2008) paper provides evidence on the U.S. DB and DC pension funds using benchmarks self-selected by pension funds. They report that DB and DC pension funds slightly underperform benchmarks and a passively managed large cap investment is, in relative terms, most attractive.9 In addition, they conclude that persistence in yearly pension fund equity performance is weak or nonexistent. In summary, this extensive evidence on investment performance of individuals either investing directly or through intermediaries leads to some key conclusions. First, left to himself (or herself), an individual investor performs poorly as he makes wrong market timing, asset selection and security selection decisions . Second, there is very little evidence that professionally managed funds outperform the passive strategy, especially after considering costs. Third, there is very little evidence that there is persistence in performance. Fourth, performance based fees may be a partial solution to reducing agency costs, but while this mechanism may be available to larger pension funds, the individual investor does not have access to it as mutual funds do not provide such performance based fee contracts.10 Fifth, to gain access to professional management, the investor incurs costs which are not compensated by excess returns. Sixth, this leaves the question as to why an individual investor would invest on her own or search for actively managed mutual funds. With this backdrop, in the following section we provide direct empirical evidence on the investment landscape faced by a typical Canadian investor and its implications on the retirement income of Canadians.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
case). Table 1 leads to the following observations. First, even after noting that the RRSP account will have tax implications at withdrawal, maximising savings through an RRSP (tax deferred vehicle) makes a significant difference depending on the investment vehicle chosen and the tax rate faced by the individual at retirement. More specifically, since interest is taxable, the table illustrates that holding debt in a RRSP account benefits more than holding equity, all else being the same. Second, the choice of investment matters. A very risk-averse investor who invests exclusively in T-Bills would have significantly less wealth than if they chose either equity or a blended portfolio. In addition, since interest is taxable, the table also illustrates that holding debt in a RRSP account benefits more than holding equity, all else being the same. Third, even after saving 18% of salary each year for 25 years, the end-period wealth can only sustain the individual for 20 years or less. 13 Fourth, being a regular and an early saver matters. There is a significant difference in the end of period wealth between a regular saver and a saver who skips some years or starts late. Note that the above example assumes that the cost of investment is zero. However, we know that is not the case and thus it is important to understand the cost structure that a typical Canadian individual investor may face.
PENSION FUNDS
As noted earlier, our data comes from various sources: public and private. Since DB plans constitute the most significant fraction of retirement assets, we started with them; the data for this part of the analysis comes from both Statistics Canada (Table 4A) which is aggregated for all funds from 1993 to 2008, and from CEM Benchmarking Inc. (Table 4B) beginning from 1990 (53 funds) to 2008 (81 funds). 14 As shown, the costs of managing DB plans vary across private versus public sector funds but on average a private sector DB plans costs are anywhere between 30 to 45 bps and corresponding figures for a public sector plan are between 25 to 35 bps. Using the CEM Data, we find that the total costs do not decline monotonically with the total asset size; for both 2007 and 2008, the costs seem to stabilise at 35 to 40 bps using data on all funds. Thus, there do not seem to be economies of scale after a particular size and expenses seem to be somewhat independent of fund size at these levels. 15 Similarly, we find very little evidence that larger funds consistently outperform smaller funds at the total fund level, not withstanding considerable differences in asset mix of these funds. We also find that the larger the fund, the larger are their investments in non-conventional and potentially non-benchmarkable and illiquid assets (e.g., private equity and hedge funds). It should also be noted that one would expect a DB plan to have a lower cost because of the nature of the plan. It is designed to provide for a stream of payments over time that are somewhat predictable, it lowers the cost of portfolio management because both inflows and outflows are lower and predictable and, the portfolio manager can invest without worrying about changes in plan members opinions about asset mix and withdrawals and having to respond to member questions. Next we focus our attention on the investment returns of pension funds in the CEM database. While we have data on every investment category, we restrict our focus to two major investment classes, Canadian equity and Canadian bonds, as these typically constitute a significant portion of pension assets. The database consists of benchmarks self-selected by pension fund respondents, but to avoid self selection bias, we use the TSE index and CDN bond Index as the respective benchmarks. The results of this comparison are shown in Table 5A and 5B. In both tables, the first column shows the year, the corresponding benchmark returns used for comparisons, # Funds, Weighted (by assets) Average Return All Funds, Weighted Average Return Funds Quartile 1, # Funds whose returns for that year are higher than the corresponding benchmark, and % Funds that exceeded the benchmark return. As can be seen, in equity portfolios, 60% of the funds exceed the benchmark returns and the performance is better more in "down" years than in "up years". This may suggest a more conservative investment policy of stock selection and changes in cash- stock mix. The results for bond portfolios are not good; except for recent years and one or two years in between, the bond portfolios have significantly underperformed the TSX DEX long-term bond index. However, one
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
can argue that the bond portfolios of the sample funds also include short-term bonds and thus the index chosen may not be representative of the benchmark. Since it is almost impossible to find the right benchmark, we consider another approach to compare the performance of sample funds. The CEM database provides data for 19 years beginning in 1990; however, the data is not available for every year or for every fund since some funds started providing data only later in the period and some funds stopped providing data in the latter part of the period. So, we decided to focus on those funds where we have at least five years of data. Next, we categorised these funds in four quartiles based on their performance (this is a standard practice). We categorised the funds based on four types of returns: total fund return, Canadian equity returns, Canadian bond returns and U.S. equity returns since the last three categories constitute a significant percentage of total assets. Table 6 shows the results of that analysis. As can be seen, we have data on gross returns for 134 funds for at least five out of the 19 years. If there was (perfect) persistence in superior performance, we would expect that the fund in quartile one (Q1) the high return quartile remains in quartile one in all the years it is in the database and, if so, this will correspond to a value of 100% in the "Q1 persistence" column. Similarly, if the fund remains in quartile 4 (Q4) low return quartile all the years, it would show a value of 100% in that column. Thus, the value of 24% in the "Q1 persistence" column indicates that, on average, a typical fund remained in first quartile for only five of the 19 years; in other years, it was in quartiles 2, 3 or 4. Similarly a value of 25% in the "Q4 persistence" column indicates that a typical fund was in Q4 for four out of 19 years. As seen from table 6, what is remarkable is the lack of any persistency over the 19 year period; while there is some year-to-year Q1 persistency displayed by some funds, they are unable to maintain their membership in Q1 over a longer period. The results are almost identical for all four categories. Although not shown here, we also see very little relationship between costs of the fund and weighted average return performance; the correlation coefficients between costs and asset weighted total returns, Canadian stock returns, Canadian bond returns and U.S. equity returns are -0.037, -0.028, -0.006 and -0.050, respectively. The overall conclusion is that pension funds in this sample do not show any consistency and do not outperform the benchmark even without accounting for costs.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
reduce the risk of investments and are affected by the timing and the amounts of deposits and withdrawals. Insurance companies, in turn, invest these amounts in mutual funds and charge an additional amount for providing these guarantees. The costs of these "guarantees" can be inferred from differences between the total cost of these investment products with guarantees and the costs of the corresponding underlying mutual fund. Table 7E provides a sample of the representative costs associated with these products. As can be seen, typical additional cost of insurance is approximately 27 bps and the cost of Guaranteed Withdrawal Balance (GWB) is an additional 62 bps. As noted earlier, these are representative numbers and would vary across insurance companies and by the underlying mutual fund category.
MUTUAL FUNDS
Mutual funds are a big part of the Canadian investment landscape as they constitute approximately $500 billion of investment by Canadians at the end of 2008. Naturally, just as the investment performance of managed mutual funds has received considerable attention, even more attention has been given to the fees (management expense Ratios MERs) charged by mutual funds especially since they do not seem to generate consistently higher returns than passive indexing. A recent paper by Khorana et al (2007) provides a comprehensive analysis of mutual fund fees using data on 46,580 mutual funds offered for sale in eighteen countries with assets in excess of $10 trillion. To account for cross sectional variations across countries, they define costs as total shareholder cost (TSC): Total Shareholder Cost = TER + initial load/5 + back-end load at five years/5 where TER, in effect, is defined as "all annual operating costs (including administration/share registration, trustee/custody, audit and legal fees), not just the basic annual management charge." Their results for year 2002 show that the TSC for Canada for bonds, equity and full sample are 1.84%, 3.00% and 2.41%, respectively. These results also show that Canada has one of the highest costs for investing through mutual funds using three different measures of management fees. Obviously there are many challenges with such cross country comparisons. 19 This Morningstar study (2007) gives Canada an overall grade of "B+". More specifically, the study gives Canada an "A" grade in Investor protection, transparency in prospectus and report, transparency in sales and media; a "B+" in distribution/Choice; a grade of "C" in taxation; and an "F" in Fees and Expenses. So if the costs are higher in Canada, it is also clear that they are well reported and with full transparency. It is also possible that other factors such as economies of scale, costly regulatory requirements and differential levels of individual advice may be at play here. In this section we provide more recent evidence on these fees and also ensure that the comparisons are made in the right context. Accordingly, we discuss mutual funds in general including Exchange Traded funds (ETFs), index funds and managed mutual funds.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
some advantages in investing in index funds over ETFs. An individual can make a regular deposit and does not have to incur costs of buying ETFs regularly ($10 per trade for an active high income investor but $30 for a regular investor). For an investor who wants to invest $1000 per month through ETFs, these costs would be significant. On the other hand, once ETFs are bought, there are no annual fees. It should be also noted that if individual wants advice as to the asset mix decisions (bond versus equity) from an advisor and then invests the funds in ETFs, the advisor may increase advisory fee since he would now get no part of trailer fees. The question really is, what is the adequate level of compensation for pure advisory services and why does one not find a large number of advisors who simply provide advisory services and do not automatically steer investors to the most cost effective funds?
As noted earlier, from the point of view of the retail mutual fund investor, they could buy an ETF or an index fund through a discount brokerage, foregoing the cost of advice and services provided by the portfolio manager and individual advisor or alternatively, they could purchase a mutual fund with portfolio management and individual advice. The primary service provided by an index fund is passive money management the buying and selling of securities to match the particular index tracked. The costs
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
associated with this portfolio management service are represented here by the management advisory fee (MAF) of the lowest cost index fund in each CIFSC category.24 The costs associated with the second choice are made up of the additional cost of the services provided by the portfolio manager25 and the additional cost of the services provided by individual advisor. 26 In addition to these costs, there are also administrative costs and GST that are included in the total management expense ratio (MER) of both passively and actively managed mutual funds. We are able to draw some broad conclusions from this analysis. First, a "do it yourself" investor can invest relatively inexpensively either through ETF or through an index fund and it would cost approximately 40 to 70 bps somewhat higher than the cost of investing through a private sector DB plan. Second, it costs approximately 70 to 80 bps to get advice from a financial advisor whose natural inclination may be to recommend managed mutual funds; this is not to say that advisors do not explain the options of ETFs and Index funds. Third, the cost of pure active management is about 60 bps. Fourth, although not shown here, there is an additional cost incurred by these funds which represents the cost of trading, termed as the Trading Expense Ratio (TER), that is almost 23 bps for equity funds and very small for bonds and approximately10 bps across all funds. However, as noted earlier, there is a considerable difference between a mutual fund and a DB plan. A mutual fund, whether passively or actively managed, must price daily, must provide a prospectus and information form annually, must provide financial statements and a report of fund performance semiannually as well as an annual report of its independent review committee among other documents. The unit holder must also receive account statements at least annually and is provided access online or by phone to his/her account balance through either the fund company or the advisor or both, 24/7. These do add to the cost structure of a mutual fund compared to a DB plan. Thus, one could say even though active management may not result in consistent excess returns; it is simply a cost of avoiding bad investment decisions that may be made by an uninformed investor.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
REFERENCES
Aggarwal, Rajesh K., Galin Georgiev, and Jake Pinato, Detecting Performance Persistence in Fund Managers, Journal of Portfolio Management 2007, pp. 110-119. Alessie, Rob, Stefan Hochguertel, and Arthur van Soest, Ownership of Stocks and Mutual Funds: A Panel Data Analysis," Review of Economics and Statistics, 2004, pp.783-796. Ang James S., Gregory L. Nagel and Jun Yang, "A Critical Long View of Capital Markets and Institutions: Realized Returns from Corporate Assets, 1950-2003", Working paper 2006.
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Antolin, P., "Pension Fund Performance", OECD Working Papers on Insurance and Private Pensions, #20, OECD Publishing, doi: 1787/240402404057, 2008. Baks, Klaas P., Andrew Metrick, and Jessica Wachter, Should Investors avoid all Actively Managed Mutual Funds? A Study in Bayesian Performance Evaluation, Journal of Finance, 2001, pp. 45-85. Barber, Brad M., and Terrence Odean, Boys will be boys: Gender, overconfidence, and common stock investment, Quarterly Journal of Economics 116, 2001, pp .261-292. Barber, Brad M., Terrence Odean, and Lu Zheng, Out of sight, out of mind: The effects of expenses on mutual fund flows, Journal of Business, 2005, pp. 2095-2119. Bauer Rob and Rik G. P. Frehen, The Performance of US Pension Funds, 2008, http://ssrn.com/abstract=965388 Bogle, John C., The Mutual Fund Industry 60 years Later: For Better Or Worse? Financial Analysts Journal, 2005, pp. 15-24. Bogle, John C., A question so important that it should be hard to think about anything else, Journal of Portfolio Management, 2008, pp. 95-102. Brown, S. J., and Goetzmann, W. N., Performance Persistence, Journal of Finance, 1995, pp. 679-698. Busse Jeffrey A., Amit Goyal and Sunil Wahal, Performance Persistence in Institutional Investment Management, http://ssrn.com/abstract=890319, June 2006, Chan, Louis K. C., Hsiu-Lang Chen, and Josef Lakonishok, On Mutual Fund Investment Styles, Review of Financial Studies, 2002, pp. 1407-1437. Carhart, Mark, On persistence in mutual fund performance, Journal of Finance, 1997, pp. 57-82. Chen, Joseph, Harrison Hong, Ming Huang, and Jeffrey Kubik, Does fund size erode mutual fund performance? The role of liquidity and organization, American Economic Review, 2004, pp.1276-1302. Cici, Gjergji, Gibson, Scott and Moussawi, Rabih, For Better or Worse? Mutual Funds in Side-By-Side Management Relationships with Hedge Funds SSRN: http://ssrn.com/abstract=905600, (December 14, 2006). Coggin, T.D., F. J. Fabozzi, and S. Rahman, The investment performance of U.S. equity Pension fund managers: An empirical Investigation, 1993, pp.1039-1055. Deaves, Richard, The Comparative Performance of Load and no-Load Mutual Funds in Canada, Canadian Journal of Administrative Sciences, 2004, pp. 326-333. Del Guercio Diane and Paula A. Tkac, The Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds vs. Pension Funds, Journal of Financial and Quantitative Analysis, 2002, pp. 523-557 Elton, Edwin, Martin Gruber, and Christopher Blake, Incentive fees and mutual Funds, Journal of Finance 2003, pp. 779-804. Fama, Eugene F., and Kenneth R. French, Mutual fund performance, working paper, Dartmouth College, 2008 Frazzini Andrea and Owen A. Lamont, Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns, Journal of Financial Economics, 2008, pp. 299-322. French, Kenneth, R., Cost of Active Investing, 2008: http://ssrn.com/abstract=1105775 Golec, Joseph and Laura Starks, Performance fee contract change and mutual fund risk, Journal of Financial Economics 2004, pp. 93-118. Gruber, M., Another puzzle: the growth in actively managed mutual funds, Journal of Finance, 1996, pp. 783-807 Jensen, Michael C. The Performance of Mutual Funds in the Period 19451964, Journal of Finance, 1968, pp. 389416. Ajay Khorana, Ajay, Henri Servaes and Peter Tufano, "Mutual Fund Fees Around the World", 2007 Forthcoming, Review of Financial Studies. Lakonishok, J., A. Shleifer, and R. W. Vishny, The structure and performance of the Money management industry, Brookings Papers on Economic Activity: Macroeconomics, 1992, pp. 339 - 391. McGuigan, Thomas P., The Difficulty of Selecting Superior Mutual Fund Performance, Journal of Financial Planning 2006, pp. 50-56. Malkiel, Burton G., Returns from Investing in Equity Mutual Funds 1971 to 1991, Journal of Finance, June 1995, pp. 549 72. Sinha Rajeeva and Vijay M. Jog, "Fund Flows and Performance: A study of Canadian Equity funds" Canadian Investment Review, summer 2007, pp.28-34. Sinha Rajeeva and Vijay M. Jog, "Performance of Canadian Mutual Funds and Investors", Advances in
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Investment Analysis and Portfolio Management, 2007, pp. 227-259. Statman, Meir, What do investors want? Journal of Portfolio Management August 2004, 153-161. Statman, Meir, Steven Thorley, and Keith Vorkink, Investor overconfidence and trading volume, Review of Financial Studies, 2006, pp. 1531-1565. Stoll, Hans R., 1993, Equity trading costs in-the-large, Journal of Portfolio Management Summer, 41-50. Sun Chengye, Review of Studies on Mutual Funds Performance, unpublished document, Sprott School of Business, Carleton University, Canada, 2009. Tonks, I., Performance persistence of pension-fund managers, Journal of Business, 2005, pp. 1917-1942. Table 1: Investment Choices and End period Wealth
Table 2 Canadian Retirement Assets Type of plan 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007
millions of dollars
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Social security Canada Pension Plan Quebec Pension Plan Employersponsored pension plans Trusteed plans 1 Public sector Private sector Government consolidated revenue arrangements 2 Other Insurance company contracts3 Government of Canada annuities 4 Deferred profit sharing plans 5 Individual registered saving plans 6 Deposits in RRSP accounts7 Mutual funds and segregated funds in RRSP accounts8 Other individual registered saving plans 9 Total assets10 54,900 54,491 60,010 62,456 70,244 84,470 101,181 121,444 145,820 157,432
40,577
40,611
41,660
46,004
52,119
65,716
78,760
94,471
113,581
122,729
14,323
13,880
18,350
16,452
18,125
18,754
22,421
26,973
32,239
34,703
322,263 523,093
818,781
792,713
778,691
850,547
180,082 61,544
165,576 60,221
177,055 58,295
180,197 67,122
184,194 77,137
188,241 86,006
193,738 94,859
199,089 102,614
30,968
38,411
53,389
49,538
51,552
57,802
61,441
66,667
70,986
73,118
829
628
495
505
427
395
369
344
331
319
1,887
2,162
7,661
10,179
6,316
8,924
15,326
18,995
23,542
29,177
135,263 273,281
411,464
409,829
378,932
428,348
500,475
570,776
641,003
739,295
97,588 134,760
102,504
104,531
106,346
110,305
110,634
110,243
111,836
114,472
12,748
74,364
188,581
190,056
175,348
193,697
211,255
231,458
250,301
251,454
24,927
64,157
120,379
115,242
97,238
124,346
178,586
229,075
278,866
373,369
512,426 850,865 1,290,255 1,264,998 1,227,867 1,363,365 1,542,408 1,740,390 1,949,059 2,119,516
Source: Statistics Canada, Latest Developments in the Canadian Economic Accounts, catalogue number 13 -605 -XIE. Notes: 1 Trusteed pension plan estimates by sector are derived by applying asset ratios for the public/private sector split from the Quarterly Trusteed Pension Fund survey to the National Balance Sheet Accounts total trusteed pension plan estimate. 2 Includes public sector retirement compensation arrangements. These supplementary employee retirement plans were set up to provide pension benefits to senior employees beyond the maximum permitted registered pension plan benefits as set out in the Income Tax Act. 3 Estimates for insurance company contracts are taken from the Canadian Health and Life Insurance Association. Estimates for 2007 were derived using the growth rate of the private sector trusteed pension plans. 4 Data for Government of Canada annuities come from the Public Accounts of Canada. 5 Estimates for deferred profit sharing plans are derived from the Survey of Financial Security and Canadian Life and Health Insurance Association survey data. 6 Estimates for individual registered saving plans are derived from the Survey of Financial Security in Canada, Canadian Life and Health Insurance Association survey data, Quarterly Survey of Financial Statements, and the Ipsos-Reid Canadian Financial Monitor. 7 Estimates for deposits are taken from the Quarterly Survey of Financial Statements and the Canadian Health and Life Insurance Association. 8 Estimates for mutual funds and segregated funds in Registered Retirement Savings Plan accounts are taken from the National Balance Sheet Accounts and the Canadian Health and Life Insurance Association, respectively. 9 Includes Registered Retirement Income Funds (RRIFs), Life income funds (LIFs), Locked -in Retirement Income Funds (LRIFs), and self -directed Registered Retirement Savings Plans (RRSPs) not captured elsewhere. 10 Excludes retirement compensation arrangements for the private sector (see note 2). Research in this area is continuing (Statistics Canada).
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Table 3 Asset Mix of Defined Benefit and Defined Contribution Plans (2006) Cutoff = $$10,000,000 Assets Total $'000
Pooled, mutual and investment funds: - Equity fund (Canadian) - Bond fund (fixed income) - Mortgage fund - Real estate fund - Money market fund - Foreign fund - Other - Sub-total Equities: - Canadian common and preferred - Foreign common and preferred - Sub-total Bonds: - Federal - Provincial - Municipal - Other Canadian (corporate) - Foreign - Sub-total Mortgages: - Residential - Nonresidential - Sub-total Real estate Cash, deposits, short-term: 1,386,429 0.2 1,250,499 0.2 1,937 0.0 133,994 0.2 0 0.0 82,319,908 54,779,203 1,411,904 9.0 6.0 0.2 76,089,914 49,864,339 1,222,278 9.1 6.0 0.1 1,355,449 899,406 44,670 6.5 4.3 0.2 4,395,947 3,784,296 140,494 8.2 7.0 0.3 478,600 231,164 4,464 8.5 4.1 0.1
Combination $'000 %
Other $'000 %
74,452,423
8.2
65,912,150
7.9
2,661,545
12.8
5,436,723
10.1
442,007
7.9
94,907,920
10.4
83,853,332
10.1
2,707,465
13.0
7,050,188
13.1 1,296,937
23.1
9,066,703
1.0
8,745,553
1.1
45,233
0.2
95,144
0.2
180,776
3.2
16,579,726
1.8
16,326,281
2.0
19,879
0.1
229,709
0.4
3,859
0.1
7,584,145
0.8
6,566,259
0.8
352,836
1.7
654,935
1.2
10,117
0.2
11.3 2.8
92,991,348 22,394,392
13.0 2.4
416,986 1,853
36.4 296,789,311
40.4 2,352,531
131,725,751
14.4 118,550,129
14.3
3,043,975
14.6
9,008,671
16.8 1,122,978
20.0
156,864,923 288,590,674
17.5 31.7
2,416,752 5,460,726
11.6 26.3
8,278,548 17,287,219
15.4
897,435
16.0 35.9
32.2 2,020,413
4.4 2.4
36,260,391 21,560,461
279,402 0 993,628
22.0 184,997,380
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
- Cash, deposits, GICs Government of Canada tbills - Foreign short-term investments - Other shortterm paper - Sub-total Miscellaneous: - Accrued interest and dividends receivable - Accounts receivable - Other assets - Sub-total Gross assets
7,425,101
0.8
6,653,954
0.8
284,247
1.4
427,624
0.8
59,277
1.1
4,246,326
0.5
3,845,439
0.5
96,239
0.5
265,471
0.5
39,178
0.7
909,241
0.1
809,234
0.1
4,823
0.0
91,384
0.2
3,802
0.1
9,997,425 22,578,092
1.1 2.5
9,029,684 20,338,310
1.1 2.4
83,353 468,660
0.4 2.3
841,880 1,626,359
1.6 3.0
42,510 144,765
0.8 2.6
2,537,685
0.3
2,360,022
0.3
46,188
0.2
121,008
0.2
10,470
0.2
3,393,121
0.4
3,162,655
0.4
24,408
0.1
200,680
0.4
5,380
0.1
17,896,859 23,827,664
2.0 2.6
17,602,133 23,124,809
2.1 2.8
89,550 160,145
0.4 0.8
204,898 526,584
0.4 1.0
279 16,128
0.0 0.3
20,786,946 100.0
Source: Statistics Canada Table 4B Canadian Defined benefit Plans Assets and Costs
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Source: CEM Benchmarking Inc. Table 5A: Comparison of Equity portfolio returns with Benchmark
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Mean
24%
25%
24%
25%
26%
25%
24%
25%
Median
24%
20%
21%
25%
22%
18%
23%
20%
Max
80%
63%
75%
67%
75%
100%
75%
100%
Min
0%
0%
0%
0%
0%
0%
0%
0%
Table 7 Assets Managed by Insurance Companies Table 7A: Management fees and net ROR by Asset type
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Table 7B: Management fees and net ROR by commissioned and Non-Commissioned
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
The total assets of sub categories do not add to 100% as come sub categories are not comparable across the respondents and to respect confidentiality are excluded in this table. Table 7D: Economies of Scale: Plan Members and Asset Size
Table 7E:
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Cost of Guarantees
Source: various annual reports Table 9 Exchange Traded Funds Costs and market Value
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Source: www.morningstar.ca Table 10 Bank managed Mutual funds Indexed and managed (non-Indexed) ($ millions)
Canadian Global - Money Market - US - Canadian Global - Candian Total/ - Equity Equity Canadian Equity - Bond Bond Balanced Average
477.57 0.68% 736.56 0.84% 185.73 0.99% 379.26 1.00% 705.40 0.99% 237.91 0.67% 187.47 1.31% 24.84 1.14% 61.02 1.07% 200.08 1.01% 3,677.73 49.64 398.26 0.63% 341.23 0.79% 150.83 0.91% 42.77 0.84% 1,163.38 0.66% 1,590.28 0.83% 398.39 0.96% 506.41 1.02% 515.48 0.99% 53.04 1.04% 30.43 1.04% 1,739.52 1.00%
Total
2,484.52
711.32
15,084.68 670.10
1,405.80
53.04
73.20
5,397.98
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Weighted Avg.
0.89%
0.99%
1.01% 0.78%
0.83%
1.04%
0.92%
0.87%
Bank
RBC
1,176.66 12,878.54 2.11% 2,118.23 1.95% 308.29 2.11% 608.38 2.31% 1.49% 2,639.20 1.99% 4,746.06 2.04% 2,192.54 1.89%
3,381.78 14,508.71 1,544.71 11,965.49 41,911.93 2.13% 1.17% 1.86% 2.18% 1.80%
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Source: Morningstar PALTrak at September 30, 2009 Table 12 Segregated Funds: Type and Expense Ratios
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Source: Morningstar PALTrak at September 30, 2009 Table 13 Costs of Active Management and Mutual funds
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Source: Investment Funds Institute of Canada Notes: 1 CIBC Asia Pacific Index Series A - cost of active management comparison calculated against asset-weighted series A MAF of actively managed funds 2 TD Canadian Index Fund Series E 3 Scotia Canadian Bond Index Fund Series F 4 ING DIRECT Streetwise Balanced Income Class 5 Creststreet Managed Equity Index Series A 6 Pro -Hedge Money Market Series F 7 TD Balanced Index Series A - cost of active management comparison calculated against asset-weighted series A MAF of actively managed funds 8 CIBC Canadian Short-Term Bond Index Series A - cost of active management comparison calculated against asset-weighted series A MAF of actively managed funds 9 CIBC Emerging Markets Index Fund Series A - cost of active management comparison calculated against asset-weighted series A MAF of actively managed 10 TD European Index Fund Series E 11 Pro FTSE RAFI Global Index Series F 12 ING DIRECT Streetwise Balanced Growth Class 13 CIBC Global Bond Index Series A - cost of active management comparison calculated against asset-weighted series A MAF of actively managed funds 14 ING DIRECT Streetwise Balanced Class 15 Pro FTSE RAFI HK China Index Series F 16 DFA International Core Equity Series F 17 TD Japanese Index Fund Series E 18 TD NASDAQ Index Fund Series E 19 TD US Index Currency Neutral Fund Series E 20 SEI US MidCap Synthetic Class P *Comparison of asset-weighted MAF of actively managed fund to the lowest cost passively managed mutual fund. Comparisons are between the series F versions unless otherwise indicated **Administration Costs include: Transfer Agent Fees, Pricing and Bookkeeping fees, Independent Review Committee fees, Custodian fees, Audit fees, Filing fees, Legal fees and Goods and Services Tax
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Source: Investment Funds Institute of Canada Notes: 1 iShares S&P Asia 50 Index Fund 2 iShares CDN Composite Index Fund 3 iShares CDN Bond Index Fund 4 65% iShares CDN Bond Index Fund /35% iShares CDN Composite Index Fund 5 60% iShares CDN Composite Index Fund / 40% iShares CDN MSCI World Index Fund 6 none available 7 50% iShares CDN Bond Index Fund / 50% iShares CDN Composite Index Fund 8 iShares CDN Bond Index Fund 9 iShares CDN MSCI Emerging Markets Index Fund 10 iShares MSCI EMU Index Fund 11 iShares CDN MSCI World Index Fund 12 35% Global Fixed Income 65% iShares CDN MSCI World Index Fund 13 30% iShares Barclays Aggregate Bond Fund/ 30% iShares S&P/Citigroup International Treasury/ 40% iShares CDN Bond Index Fund 14 50% Global Fixed Income 50% iShares CDN MSCI World Index Fund 15 iShares FTSE China (HK Listed) Index Fund 16 iShares CDN EAFE International Index Fund 17 iShares MSCI Japan Index Fund 18 iShares S&P North American Technology Sector Index Fund 19 iShares CDN S&P 500 Hedged to Canadian Dollars Index Fund 20 iShares CDN Russell 2000 Index Fund
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Exhibit 1: Studies in Performance of Mutual funds categorised by key attributes. Source: Chengye Sun (2009)
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Note: in 2008 TSX had a -33 percent return and as consequence the 2008 value would have been $1,763.43. The corresponding value for LT bonds and T-bills would have been $134.59 and $41.55, respectively. Source: Fundamentals of Corporate Finance Richard Brealey, Stewart Myers, Alan Marcus, Elizabeth Maynes and Devashis Mitra, McGraw Hill Ryerson, Third Canadian Edition. Exhibit 3 Value of $1 invested in 1956
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Compiled by the author. Source: IFIC. Exhibit 4 Investment returns from 1984
Compiled by the author. Source: IFIC. Exhibit 5A: Insurance Company Managed Assets
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
of the Funds are of sufficient size to reasonably absorb all management and advisory fees and expenses incurred in their operation. Trading Expense Ratio (TER): The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average Net Asset Value of the Fund during the period. In some cases, TERs are charged at different rates for each series in other cases there is one rate charged to the Fund as a whole. It does not include trailer commissions, which are paid by the fund management company out of their management advisory fees (MAF) and is not included in the MER. Therefore, the total on-going cost of ownership would be the MER plus the TER. Gross versus net Returns: If the reported net return is 5% for the year and the MER was 2% and TER was 0.4% then the gross return is roughly 7.4%.
2 It should be noted that segregated funds managed by insurance companies for workplace plans are not the same as the segregated funds in the retail world. More specifically, retail segregated funds include an insurance component that guarantees a specific return on the investor's capital at maturity. However, segregated funds that cater to group RRSPs or defined contribution plan simply mean that the market based assets are kept separate from the general assets of the company. These segregated funds, in turn, buy units in the underlying pooled or mutual funds. This has implications on the corresponding costs as we note later in the paper. 3
They state that the average commission paid when a security is purchased is 2.23% of the purchase price. The average commission on a sale is 2.76% of the sale price. Thus, if one security is sold and the sale proceeds are used to buy another security, the total commissions for the sale and purchase averaged about 5%. However, in the last 10 years, due to the growth in discount brokerage houses, costs of trading a security have declined significantly. Ontario Securities Act Sec. 1(1). The other two types are closed-end fund and unit investment trust.
4 5
The top finance 10 journals are ranked by Oltheten et al (2005); they are (listed by ranking): Journal of Finance (JF), Journal of Financial Economics (JFE), Review of Financial Studies (RFS), Journal of Financial and Quantitative Analysis (JFQA), Journal of Business (JB), American Economic Review (AER), Journal of Political Economy (JPE), Econometrica (ECO), Journal of Banking and Finance (JBF), and Financial Management (FM).We also include Journal of Portfolio Management (JPM) and Financial Analyst Journal (FAJ). The number of published mutual fund studies has been growing rapidly over years. From 1991 to 1995, 11 papers were published, while from 2001 to 2005, 64 papers were published, the number is five times larger. From 2006 to 2008, 32 studies were published.
6
This does not mean that an advisor steers the investor where he (the advisor) receives the highest fees, actually the fees seem to vary little across various mutual funds. For example, for most equity funds the standard is a 0.5% trailer fee and 1% when it is sold front-end. Fixed income funds will tend to have lower trailers followed by money market funds. Clearly, advisors do have motivation beyond just earning high fees; these include building and retaining client assets by providing them the best advice from a risk-adjusted return point of view, However, it is also natural that the motivation to steer a client into a low fee, no trailer-no front end loaded mutual fund with similar risk-return characteristics may not be there. A recent paper by Antolini (2008) provides a comparison of aggregate pension fund performance by country on a risk adjusted basis using relatively standard investment performance measures. He concludes that, in spite of the data limitations, pension funds have generally outperformed a hypothetical but realistic benchmark portfolio; his results for Canada shows a 2% excess returns by pension funds during the 1990-2005 period. However, Christopherson et al. (1998) do find some evidence of persistence but among poorly performing investment managers. They also focus on comparing the pension fund performance with mutual funds matched for size and type and conclude (self evident) that pension funds do better than mutual funds net of costs. However, it is not clear that such comparison is a valid one. First, the benchmarks were self selected by the reporting pension funds in their data set and second, mutual funds are for profit and provide a multitude of other services to individual retail investors and thus naturally have a very different cost structure. For some mixed evidence, please see Elton et al (2003) and Cici et al (2006).
10
11 These are important assumptions since the benefit of RRSP-type vehicles is directly dependent on the tax rates faced by the individual during her working life and during the post-retirement period. 12 We have arbitrarily selected years 1986, 1991, 1997, 2001 and 2005 as years where investor did not save. 13 This is an illustrative example and we have excluded the implications of taxes post withdrawal period, expected returns on the portfolio and inflation in the post- 2008 period. All these can be easily modeled. Also note that OAS/CPP combine to provide an indexed life annuity of about $18,000/yr as a base. 14
15 CEM analysis using global funds as well as Canadian funds shows economies of scale after accounting for differences in asset mix of funds. It also claims that larger funds perform relatively better than smaller funds meaning return to cost ratio improves as size improves. However, our somewhat simpler
Archived - Investment Performance and Costs of Pension and other Retirement Savings Funds in Canada: Implications on Wealth Accumulation and Retirement
analysis using all Canadian funds and only at the aggregate level (using correlation coefficients and sorting by asset size) indicates that these correlations between assets size, cost and returns vary considerably across years.
16 These costs often referred to as fund management fees include, but are not limited to, operating expenses for both the segregated fund or mutual fund and any underlying fund, and investment management fees. Investment management fees pay for professional investment managers to select the fund's investments. These fees also pay for keeping records of accounts, GST and other member servicing costs. Operating expenses for both the segregated fund or mutual fund and any underlying fund are generally made up of brokerage commissions and other expenses of buying and selling securities for a fund and any expenses relating to the operation of a fund, including legal, audit, trustee, custodial and safekeeping fees, interest, operating and administrative costs (other than advertising, distribution and promotional expenses), member servicing costs and costs of financial and other reports used by the fund.
The "commissions" in these plans are paid to an advisor as compensation for the plan-related services they provide to the employer as well as plan member services such as personalised investment advice and investment education.
18 A detailed explanation of each of these guaranteed products is beyond the scope of this paper. However, the information is readily available from any insurance company that sells these products. 19 This study is also not without its challenges, the most notable being that it is based simply on the perceptions of Morningstar analysts. 20 An ETF is an investment vehicle that combines key features of traditional mutual funds and individual stocks. ETFs are open-ended funds which, like index mutual funds, represent portfolios of securities that track specific indexes. A distinct difference is that ETFs trade like stocks and can be bought and sold (long or short) on an exchange and can employ the same trading strategies used with stocks. ETF units can essentially provide unlimited liquidity. 21 Although not shown in detail here, we also analysed 108 funds comprising of $48 billion that are classified as 5 Star funds by Morningstar. The methodology followed by Morningstar for its ratings is as follows. For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund's monthly performance (including the effects of sales charges, loads and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.) The top 10% of the funds in an investment category receive 5 stars, 22.5% receive 4 stars, 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating is a weighted average of the funds' three-, five-, and 10-year (if applicable). We found that the weighted MERs are significantly lower than average MERs, meaning larger MFs have a lower MER and that the MERs range from 234 bps for Canadian equity funds, 160 bps for equity and approximately 40 bps for bonds and money markets.. We also calculated various correlations between asset size, MERs and performance and found a negative correlation between asset size and MERs meaning that larger funds have lower MERs; however even in the 5 star funds, the correlation between MERs and performance is negative for both 1-year and 3 year performance; higher MERs do not seem to result in higher returns. 22 We thank Dennis Yanchus of Investment Fund Institute of Canada for the detailed data and analysis used in these tables. 23 CIFSC stands for Canadian Investment Funds Standards Committee which classifies each fund in 20 categories. 24
17
Only CIFSC categories which have an index fund option available are represented in table 13 and 14.
25 This is represented by the difference between the MAF of the index fund and asset-weighted MAF of a sample of actively managed funds within the CIFSC category. 26 This is represented by the difference between the MAF charged by active fund managers on their retail versus fee-based mutual fund series. See the glossary for more details.
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