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What’s in your mutual fund?

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If you’re like many Canadians with even the smallest registered retirement saving plan you invest in a Canadian equity mutual fund.

It’s a staple for the average portfolio and the first fund investment advisers put new clients in because big Canadian companies tend to be solid, familiar and deal in Canadian dollars.

The problem is; many of the 100 or so significant Canadian equity funds on the market look very much alike. That’s because there aren’t a lot of big Canadian companies other than the big five banks and natural resource giants like Suncor Energy and Barrick Gold.

That means managing a Canadian equity fund is basically a matter of shuffling around a limited number of stocks listed on the TSX Composite, in different quantities, at different times.

The Cost

For that service – along with basic administration costs, sales commissions and marketing - mutual fund companies charge an annual fee called a management expense ratio (MER). The average MER on a Canadian equity fund is about 2.4 per cent.

At the halfway point of 2013 the vast majority of mutual fund managers have earned those MERs. Even when you subtract half of the annual average MER of 2.4 per cent, only a handful are under performing the benchmark TSX Total Return Index, which has advanced 0.24 per cent so far this year.

The best performer so far this year is the Fidelity True North fund with a 10 per cent gain.

The Long Haul

Mutual funds are intended to be long-term investments, however, and over the long term most Canadian mutual funds underperform the TSX Total Return Index. Over the past 10 years the average Canadian equity fund has returned 7.3 per cent on average each year. Compare that with the average return for the TSX Total Return Index of 9.1 per cent and that’s an annual shortfall of 1.8 per cent.

In most cases it’s the annual fees that keep Canadian mutual funds from performing better than the index.

Investors would have been further ahead purchasing an exchange traded fund (ETF) that tracks the TSX Total Return Index. Annual fees for most ETFs are below half of a per cent, which would bring the average annual 10-year return above 8.5 per cent.

Winners and Losers

That’s not to say professional management doesn’t matter with Canadian equity funds. Over the past decade many have consistently outperformed the TSX including the Mawer Canadian Equity Fund which posts an average annual 10-year return of 10.4 per cent.

Even better, the Mawer fund consistently posted strong returns while most other funds, and even the index, fluctuated from year to year. Some of that extra return comes from not having to pay a big fee. The MER is 1.23 per cent.

Contrast that with the Templeton Canadian Stock fund which has only managed to squeak out a 4.3 per cent annual average return over the past 10 years. Many of the top holdings are the same as the Mawer fund but the MER is an above average 2.68 per cent and investors must pay an additional fee, called a load, when it is purchased or sold.

Do your Homework

The point is; if you are going to pay for professional management in a Canadian equity fund get the right fund. A good advisor should suggest a fund with consistently strong performance and low fees, but in some cases they may favour funds that pay them the highest commissions.

If you go through an advisor ask about long-term performance and fees. Also, ask the advisor how he or she is compensated.

If you’re going it alone research funds on the fund company websites or websites from independent fund trackers.

Management does matter.

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