Friday, October 8, 2010

Should I choose a lower MER unit trust fund?

What is MER?
Management Expense Ratio. Generally the management fee.

Now let's take a closer look at 2 actual mutual funds.
Fidelity Canadian Disciplined Equity

1 Year: 9.90%
3 Year: 17.79%
5 Year: 18.45%
10 Year: N/A
Inception: 15.54% (September 1998)
TD Canadian Value

1 Year: -2.51%
3 Year: 11.36%
5 Year: 14.22%
10 Year: 6.30%
Inception: 9.30%(December 1993)
*All figures as of April 30 th 2008. Source: Globefund.com
Here's an actual example using 3-year figures:
Fidelity Canadian Disciplined Equity

Earnings before expenses 20.02%
MER 2.23%
Standard Deviation 11.5
Reported Return 17.79%

TD Canadian Value
Earnings before expenses 13.45%
MER 2.09%
Standard Deviation 11.6
Reported Return 11.36%

Again, looking at the 2 funds we can learn a few things. They are both Canadian Equity funds that have roughly the same degree of risk over the past few years, but oddly, the fund with the higher MER also has the higher reported return over the 3-year period. We can also read between the lines and determine that the holdings within each fund must be different to result in such a broad range of performance over the past 3 years.

So, what does this do to the theory that a lower MER is better for the investor? The answer is that it is not conclusive proof that a lower MER is better or worse for an investor. The above is only one of thousands of examples. Some examples will show that a lower MER provides a higher net return and some wont.

So where does this leave us? The answer may upset you, but here it is. MERs are irrelevant! To put this in perspective, and to make sure you don't get the wrong idea, I'd better explain what I mean. Again, all things being equal, a lower MER is in an investor's best interest. We all know things aren't equal and human beings manage mutual funds and some human beings are better than others at their jobs and the world doesn't always react the way we expect etc etc. The bottom line is that it's the net return to the investor that's most important. Obviously a company that has lower fees will have an easier time delivering a higher net return but there's no guarantee that this will always be the case.

If you build a portfolio that focuses first on sourcing funds with the lowest MERs, you may actually be doing yourself some harm. First, focus on funds that provide the highest consistent return in any category with the least amount of risk. Beyond that things can get a bit more complicated when you consider that you want to reduce duplication in management style while maintaining exposure to as many different asset classes and diversifying geographically at the same time, but that's another story.

The bottom line is that MERs shouldn't play as big a part in your selection of funds. Instead, focus on the net return.