Friday, May 25, 2012

One Small Step For Investors, One Small Set Back for Investors Group

The sudden announcement that Investors Group will lower MERs (the hidden fee an investor pays every year to hold a firms mutual funds) on two thirds of their funds is a victory for retail investors (that’s you if you own IC funds). The fees are being reduced by approximately 0.4% to 0.5% per year. In short you will save approximately $450.00 every year for each $100,000.00 in IG funds you own! Given IG has approximately $60 billion in funds it manages, and using the two thirds ratio, that means Canadian investors will see annual fees drop by a collective $180 million dollars annually!

As a backgrounder, IG is extremely large in the Canadian Fund industry and has been known historically for charging MERs that were relatively high compared to their peers. In fact, IG is a primary reason why fund fees in Canada are deemed the highest in the developed world! Given the size of IG you would have expected an economy of scale advantage that would have enabled the firm to be a low cost provider in Canada. Instead, Investors Group took the approach that Canadian investors are fee tolerant and either did not care or did not react to very high fees. In short, small uninformed investors are ripe for being fleeced on fees. In fairness to IG, that seems to have been a smart bet over the past couple of decades. IG has built a huge business by being everywhere with a horde of well trained sales people. The sales pitch has been slick and having sales people coming into investors homes has built a huge base of goodwill and trust. Almost every Canadian town has a ball team, hockey team, or soccer team sponsored by the local IG office. In fact, IG has been to fund companies as Tim Horton’s has been to coffee shops.....that is if Tim’s charged $3.00 for a double double!

Investors Group has always downplayed fees and promoted the softer benefits of having a financial plan and a trusted hand to guide investors. At the same time, however, IG has kept fees high across the board. If investors try to leave IG they often find themselves having to pay thousands in penalties that the investor did not really understand. By selling large quantities of funds with Deferred Sales Charges (DSC or Back-end Loads) IG has reaped a windfall of profits even as dissatisfied investors have left. Which brings us to the crux of the matter for Investors Group: Investors have been paying the penalties, albeit not happily, and moving on to firms that charge lower fees. Consumers have become more informed, thanks in no small part to journalists such as Jonathan Chevreau (ex-National Post, Money Sense) and Rob Carrick (Globe & Mail), and fee only advice firms such as Weigh House. As well blogs, a new breed of low cost fund firms (Steadyhand, Mawer, ING, TD eFunds), and a more cynical attitude towards big financial firms has helped spread the story on fund fees in Canada.

How has this impacted Investors Group? For a long time now the IG fund family has struggled to provide quality returns. Since returns are shown net of the MER, the fund managers at IG need to overcome the impact of the large fees when comparing returns with funds who charge lower fees. This problem becomes even more challenging when fund performance is measured against low cost exchange traded funds (ETFs are the fastest growing segment of the fund market worldwide and in Canada). The result is that IG has amongst the lowest percentage of funds of all the major fund families ranked in the top categories by independent rating firm, Morningstar. Although very large, IG has only 18% of funds ranked 4 or 5 stars out of 5 on the Morningstar scale. On average fund families have 28% of funds ranked in the 4 or 5 category.

This has resulted in retail investors shunning the mediocre performers. IG has had net outflows of funds for the last three quarters. In Q1 2012, year over year inflows dropped by 65%. When these types of numbers are appearing it likely follows that the sales team at IG is starting to defect. With sales driven by relationships, a salesperson often takes a large number of clients with them when they defect. In the fund industry competitors will often make it attractive for sales teams to switch firms. Being able to show existing clients that a new firm has better ratings and lower fees is a big sales assist for disgruntled sales people.

So, in the end IG is making the changes necessary to ensure they can continue to retain sales teams. They are not making changes in order to benefit investors nor are they reducing the fees on all their funds. What is happening is that IG is being forced to acknowledge that the days of fat profit margins and poor performance are threatened. IG is a smart company and they will spin their decision to seem more consumer focused than it is. The way to force changes is to threaten profits and thousands of small investors have done just that! It is the first small step in a long journey but it is a welcome site for all investor advocates.

In the end IG will act in an economically sensible way, as they always have. The company still has a large profitable business and a large well trained sales team. They will make revenue adjustments when forced to and not a moment before. That is no different than a bank lowering a credit card rate or a car company dropping prices. The main difference is that MERs are hidden from monthly statements and thus consumer awareness is slower to develop. While many advocates hold IG in contempt for gouging consumers for decades, the truth is always somewhere in the middle. IG exploited a business opportunity which is now being slowly eroded. As retail investors continue to become more enlightened IG will find new areas to exploit. This is more evolution than revolution but it is a great start on the road to a fair and level investment market for Canadians.

In the meantime, congratulations to the thousands of investors who voted with their wallets and forced a major change in the behaviour of the fund industry! Keep up the great work!



Kevin said...

Hi Mike,

Thanks for sharing your thoughts on IG MER fees. I recently started a MF portfolio with IG. I was happy with the service I was getting with my IG advisor (purchased Life Insurance and Critical Illness), so I decided to invest Pre-Authorized Contribution (PAC) of $50 bi-weekly into a DSC fund. I was told that if I didn't need the money right away and that I was willing to let it sit for a long period of time, to invest in a DSC fund. Even though my portfolio isn't a large one per se, do you think I should continue to contribute into the DSC fund until I hit the 0% mark in 6 years or get out of it immediately and save myself from potential loss from minimal returns and fees?

Thanks for your input!

soismike said...

DSC funds lock you into a significant penalty should you feel the need to cash in or move your investments. The DSC assures a quick commission payment to the advisor up front and inturn the advisor has guaranteed you will either stay in the fund or pay the fund company (IG) an amount that will cover the commission expense if you try to leave. There is no real benefit to the investor. My basic guide for investors is to keep fees low and remain flexible to get in or out of the markets. IG typically have higher fees than other funds (check low cost fund companies such as Mawer (direct purchase),Steadyhand,Vanguard, or any ETF that is passively managed etc).
By making on-going contributions you extend the DSC to another 7 years or so with each purchase. I caution that "liking" an advisor is not a good sign. Treat your advisor as an employee (you are paying thier income) and hold them accountable to a reasonable benchmark return AFTER fees.