Despite continuing pressure on mutual fund costs, advisor highlights importance of 'teaching moments' for clients
Given investors’ continuing fee sensitivity, regulatory pressures, and fund product innovation, the story of falling costs in the mutual fund space certainly won’t be ending soon. But as one advisor points out, that doesn’t mean conversations with clients should begin and end with fees.
“ETFs and lower-cost funds have been the trend for a number of years now. And ETF sales have eclipsed inflows into higher-cost mutual funds over time,” says Jason De Thomasis, financial planner and Chief Compliance Officer at De Thomas Wealth Management. “But there's been different periods where more expensive funds have had similar inflows.”
Because Canadian mutual fund fees have tended to include distribution and advisor commissions – some of that will go away with the upcoming ban on deferred sales charges, and more advisors moving to fee-only models – Canadian investors have tended to experience higher investment fund costs compared to other jurisdictions. But over the years, fund companies have taken steps to either decrease fees for their funds or introduced lower-cost options, and De Thomasis doesn’t see that trend waning.
At the core of the fund-fee debate is the question of value: do investors actually get more when they pay more? There’s been plenty of research to show Canadian active funds have tended to underperform their benchmarks – in other words, active fund investors are likely to have been better off just buying passive, low-cost exposure to the broad benchmark or market.
Of course, that’s not necessarily how clients approach the question. “A lot of times, people just compare the performance of a fund they have to a random benchmark, or to a friend, or to another fund or a stock,” De Thomasis says. “Other times, they might compare the worst-performing active funds to the best-performing passives. So when we have these conversations with clients, I see them as teaching moments.”
Investors who focus too much on beating a particular benchmark, he says, may lose sight of the metrics that actually matter. Some may underperform the market but still be on track to meet their long-term goals, for example. Other times, the returns shown in the benchmark may not properly reflect the risks that it currently contains in terms of valuations or return volatility.
Those types of conversations are hard to get into when equity markets are consistently rising. But in a climate of higher volatility and uncertainty in the broad market, the case for diversifying a portfolio into more active or niche strategies is easier to make. Even then, De Thomasis says advisors have to approach the topic delicately.
“In a low market like we’re in right now, a lot of the funds are defensive, and they are helping. But that's not always the case,” he says. “The way I look at it in my own practice is, you should use active, higher-cost funds for the niche exposures to include in a portfolio to complement passive market exposure. You should also make sure those products can’t be matched in a lower-cost alternative.”
Another point to emphasize, he says, is that low-cost passive funds shouldn’t be added solely because they have near-zero fees, especially since a lot of low-cost funds can also add zero value or carry more risk than meets the eye. Giving investors access to vehicles with rock-bottom fees, he argues, can also make them more prone to speculative trading and taking unnecessary chances.
Advisors should also underscore how diversification into higher-cost, specialized strategies can help hedge against different scenarios, recommending investments based on historical data about their performance in specific market contexts and how well they go with other types of investments.
“I make sure recommendations are tailored to the specific client I'm dealing with based on tangible aspects such as income, assets, and net worth. I also have to make judgment calls based on what I know about the client's behavioural responses to certain conditions, and whether I think this is a good investment for myself,” he adds. “If it's too volatile, or doesn't fit a client's objective, it shouldn't be included in the client portfolio.”