You may have heard that some mutual fund companies are reducing management fees. You might even own funds that have recently cut fees. But what are management fees and how do they affect your investments?
Management fees are paid by mutual funds to the organizations that manage fund assets. These are the professional money managers who run fund portfolios. Among other things, their job includes researching, building and managing the portfolio. In return for investing the money contributed to a fund by unitholders, these managers are paid for their services and the costs they incur. It’s similar to an individual investor hiring a professional to manage assets, only on a larger scale.
As a mutual fund investor, you pay for these services. But you don’t pay directly; instead, the returns you receive from your investment are reduced by the management fee paid out of fund assets. The total amount you’re accountable for depends on how many fund units you own.
Management fees are calculated as a fixed percentage of the average net asset value of a fund over the year. Net asset value is the fund’s total assets, minus current liabilities. The percentage figure represents the proportion of each dollar of fund assets that go toward management services.
The level of management fees is closely related to the amount of work and expertise involved in managing a fund. Equity funds typically have the highest fees because of the complexities of researching, selecting and managing portfolios. At the other end of the spectrum, funds that invest in easy-to manage-money market investments have low fees. So do “passively managed” funds such as index funds whose returns are designed to track those of stock market indexes or other market benchmarks.
Management fees paid by a fund are lumped in with other costs as part of the “management expense ratio.” Other items in the MER typically include legal and audit fees. MERs of individual funds vary, but generally range up to 3% of asset value. Think of the MER as the cost of running the fund, expressed as a percentage of assets.
You can find the MER and details on management fees in a mutual fund’s prospectus and financial statements.
Many mutual fund reports published in the financial press, as well as details published on Internet sites, indicate MERs for funds. It’s important to note that the returns reported by mutual funds and the value of your investments have already factored in the MER. For example, a fund with a 10% return on investments and a 2% MER would report a return of 8%. Likewise, the fund’s unit value reflects deducted management expenses. However, that doesn’t mean you shouldn’t be concerned about management fees and other costs.
The higher those expenses, the lower the return you receive. Conversely, lower expenses mean money in your pocket.
Recently some fund companies have recognized investor concerns about fees in a competitive environment by reducing MERs. This benefits investors because they receive a greater share of investment proceeds. And by reducing MERs, companies hope to attract more investors.
You should always pay attention to management fees and MERs. But never base your decision on fees alone. Saving on fees won’t get you anywhere if the management team produces poor results.
For more information on how fees affect your mutual fund portfolio, speak to your advisor.
Deborah Leahy is an Investment Advisor with Edward Jones
Member Canadian Investor Protection Fund