A tale of two investments: ETFs and Mutual Funds
What are you paying for?
There has been a lot of talk about the cost of exchange-traded funds (ETFs) in the marketplace and comparing their management fees with mutual fund equivalents. A recent campaign suggested the difference in fees between an ETF and mutual fund is as much as 173 basis points (bps) or 1.73%1. There are a few ways to make this calculation, but even if we assume the numbers are correct, we believe there are still many reasons to suggest that mutual funds are a great choice. While we agree that fees should be a consideration when deciding on an investment, they shouldn’t be the only one. At the end of the day, achieving the highest amount of potential investment return for your personal risk tolerance is still the best approach to making investment choices.
One of the biggest differences in the pricing of ETFs and many mutual funds is the cost of advice. Mutual funds typically bundle in the cost of advice into their management fees, while ETFs do not. If you’re paying for advice with ETFs, it’s usually after the ETF fee. For a proper ‘apples to apples’ comparison with mutual funds, that fee should be included. In the case of equity mutual funds, that can subtract as much as 100 bps of the potential 173 bps gap in fees for a front end load.
ETFs typically rely on a passive strategy: they can seek to replicate the performance of an investment index. As an example, an ETF that replicates the performance of the S&P 500 Index simply buys 500 large cap companies listed on stock exchanges in the United States in an appropriate mix to mimic the index. The good news with this approach is it’s easy to execute. You don’t need to pay portfolio managers and analysts to try and figure out which companies are the good ones, and which ones are the bad ones, you simply buy them all. That’s one reason why the fees are so low. The result is an ETF that seeks to perform the same as the index, with a little drag for fees. But is that the best performance for a given amount of risk? The truth is that not every mutual fund will beat its index over time, but certainly some will. The average Canadian can’t dunk a basketball, or break 100 for 18 holes of golf. That doesn’t mean it’s impossible, or even very rare. You don’t have to look very far to see this concept in action. In 2013, the majority of Canadian active managers saw investment returns higher than their benchmarks with two thirds of Canadian equity mutual funds outperforming the S&P/TSX Composite Index2.
The value of advice
Aiming to achieve the highest investment return that’s consistent with a personal risk tolerance is the goal for many investors. With thousands of investment options available in Canada, it can be tricky and time-consuming for many investors to figure out which ones to choose. Hiring an advisor to help you select, and just as importantly, monitor those investments, can help you create a financial plan to reach your goals. Left to their own devices, some investors may be inclined to buy and sell at the wrong times.
Separating investor returns from mutual fund returns
Morningstar, a global investment research firm, studied investors and mutual funds’ performance over 10 years – from 2000 to 2010 in the United States3. They found that the average investors’ return was 168 bps worse than the return of the mutual funds they were buying. How is that possible? Poor market timing may be the biggest driver: buying high and selling low. This is another place where advisors may help improve investment returns by acting as an emotional anchor. Advisors may help you stay the course when markets get rocky, and help you avoid putting everything into the markets when it seems as though it’s going nowhere but up.
The bottom line?
We believe achieving the best possible investment return in line with personal risk tolerance is the best approach for investors. Cost is only one consideration when it comes to selecting an investment; there are many others to bear in mind. Advisors can help investors set goals, create a financial plan and practice resilience when it comes to market ups and downs.
1 Advisor’s Edge Report, vol. 12 no. 4, April 2014. Rogers Publishing Limited.
2 SPIVA Canada Scorecard, Year-End 2013. S&P Dow Jones Indices, McGraw Hill Financial.
3“How the average investor’s returns compare with the average fund’s.” Morningstar Inc. Data through 12/31/2009.
Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This brochure should not be construed as providing specific individual financial, investment, tax, or legal advice. Investors should speak with their professional advisors before acting on any information contained in this document.
©Sun Life Global Investments (Canada) Inc., 2014. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.