November 05, 2024

Shining a Light on Investment Management Fees: Questions to Ask

When friends or family ask me how to make money in the market, I offer three pieces of advice:

1. On investing: Start early, contribute often, and stick to the plan through good markets and bad
2. On the firm: Work with a firm whose investment philosophy makes sense to you, has stability in their process, and employs people you trust
3. On cost: Make sure you’re not overpaying for fees – be bold and ask tough questions about what you’re being charged

For #3, unfortunately poor transparency and slow (but improving) regulation has enabled some members of the financial services industry to operate in the shadows around what clients are being charged. To combat this confusion, Canadian regulators rolled out something called “Client Relationship Model 2” (CRM2) back in 2017, which was a set of rules governing what investment dealers and advisors must tell their clients about the fees they’re charging, and its impact on their net performance. CRM2 pointed a flashlight at what were historically opaque fees. Through this post, we hope to upgrade the wattage a bit and illuminate the whole picture.

Ask your advisor: In addition to any advisory fees, what other fees are charged by funds I’m invested in? Taking those into account, what are my total fees as a percentage of assets and in dollar terms?

This stuff can be complicated, so let’s start with defining some terms:

• Discretionary or Advisor fee: the “cash” payment that you pay to a discretionary investment counsellor or fee-based advisor who manages your account for you.
• Management Expense Ratio (MER): the fee that you are charged on top of your discretionary or advisor fee, by any pooled funds you hold.

What MERs are you paying? MERs will vary by strategy, manager, and what type of advisor you are working with. I’ve organized them in ascending order by MER fee load.

Level 1 - Discretionary Investment Counsellor: That’s Leith Wheeler. We also have a number of peers in Canada who have the same model whereby we manage most of the strategies in-house.

We charge a discretionary fee that covers both service and the cost of investment management, and then pass along a small additional fee to cover fund administration and operating costs.

Ballpark MER: 0.02% – 0.20%

Level 2 - Fee-based advisor: Think of bank-owned dealers, other brokerage houses, and other wealth advisory firms. Their parent firms may manage strategies for you in house, or they may not.

Like investment counsellors, fee-based advisors charge a fee based on assets but may hold funds by third party investment managers. The MER therefore can contain a management fee element to compensate the 3^rd party investment manager who manages the fund. As a result, it’s higher than Level 1, but as we’ll see, less than Level 3. DIY investors who access funds via a third-party platform also pay these MERs. Exchange Traded Funds (ETFs) fit in this category and while the index-tracking versions are known for their low cost, the category has expanded in recent years to include active strategies that walk and talk like mutual funds – and can carry higher fee loads. Best to double check.

Ballpark MER: 0.7%-1.0% for fixed income and balanced funds, 1.0% - 1.2% for equity funds

Level 3 - Retail broker: Again, an advisor employed by a dealer or brokerage house but one who is compensated by charging commissions on trades and holding funds for you that pay them a trailer fee. If your advisor doesn’t invoice you for anything, you are likely paying the highest MER. Like Level 2, the MER includes an investment management fee, but it also collects a trailing commission that is paid to your advisor when he/she puts client assets into the fund. Regulators recognize the conflict of interest in these structures, and so require advisors and fund companies to disclose these arrangements to their clients (e.g. in the fund’s prospectus). By paying the MER, you ultimately pay these costs. You could research the fund structures yourself by reading the prospectuses, but your best bet is to ask your advisor to spell it out for you.

Ballpark MER: Really varies. Generally add at least 1.0% to Level 2 fees.

The quiet impact of MERs on net performance

Say you hire an advisor to manage $1 million for you and they charge a 1% annual advisory fee. They invest the money in units of a Canadian Equity Fund that also charges a 1% annual MER. At close of markets on March 31, the fund is up 2%. Great! Overnight, the price of the fund is automatically adjusted down by 0.25% – one quarter of the 1% MER – so that at the open on April 1 you’re actually up only 1.75%. At this point, the advisory fee is also redeemed and paid out (0.25% of assets per quarter), so in effect, you’ve actually earned 1.5% this quarter net of fees. To illustrate MERs in action, Figure 1 shows the impact of total fees on quarterly and annual returns of a sample portfolio that earns gross returns of 2% per quarter and 8% per year and charges these fees.

Figure 1: Impact of 1% advisory fee and 1% MER on quarterly and annual returns

Compounded over time, the 1% MER can make a huge difference to your portfolio assets: assuming the fund generates an 8% return per year for 20 years, after advisory fees, your $1 million would grow to nearly $3.9 million (7% net performance). After advisory fees and MERs (6% net performance), it would sit at just $3.2 million – a difference of over $660,000 in your retirement account. (Fees above include taxes.) See Figure 2.

Figure 2: Impact of MER on portfolio assets over 20 years.

Read the fine print: MERs for funds that invest in strategies like private equity, real estate, or infrastructure can be significantly higher than public funds, so if your advisor has not built them into your advisory fee, be sure to understand what embedded MERs you are paying. Figure 3 shows what the actual fees could look like on a $1 million portfolio that charges an advisory fee and spreads the portfolio across a sample allocation of public and private asset funds. In this example, the headline “1%” advisory fee is just the tip of the iceberg, with total fees coming in closer to 2.4%, for an incremental 1.4%, or $14,000 in annual fees.

Figure 3: Hypothetical Fee Breakdown for a Balanced Portfolio with Private Asset Allocations

Ask your advisor: Do you offer fee breaks as asset levels go through certain thresholds? What would the fee be on my portfolio when it’s 50%, 100%, or 200% larger than it is today? Do you have systems in place to capture and reflect fee breaks in your bill when assets rise above those thresholds?

For managers who charge an advisory fee based on a percentage of assets, you will generally encounter one of two models: a flat fee that you pay on all assets within a certain range (popular among retail brokers), or a tiered fee paid on assets above certain thresholds (popular among investment counsellors and institutional managers). We recommend asking what the fee would be today, along with how it may change as your portfolio increases over time. If you expect your wealth to grow (don’t we all?), what may look good today may not in fact be your best / lowest-cost, long-term option.

Also, while it is great in theory to see your fee rate decline as your portfolio grows, not all advisors have robust enough systems to automatically catch and apply this benefit. We recommend monitoring over time to ensure what’s been promised is being delivered, especially if you are moving to a higher “rung” of the investment arms of a bank. All else equal, as you move from the branch to the broker-dealer to the investment counsel arm, your fees, as a percentage of your portfolio, should go down.


A Note on Leith Wheeler Fund Fees: We prioritize transparency in our fee discussions with clients. For the pooled funds we manage internally for our discretionary clients, we charge the Level 1-style MER that only includes operating costs and taxes (generally 0.02% - 0.10%). Fee-based advisors who use our funds pass along Level 2 MERs. We do utilize sub-advisors on some strategies such as private assets, which can incur an incremental fee which are fully disclosed to clients up front. When you sign up and over time, the fees are what you think they are.

Regulators have expanded the transparency requirements on costs in “CRM3,” which is commonly referred to as “Total Cost Reporting.” It will roll out at the end of 2026. In the meantime, ask the hard questions up front. Gather all the relevant information. And in doing so, make an informed decision that will serve you through your retirement.

*Note on annual net return: I’ve shown the simple annual numbers in the table for ease of comprehension. Due to compounding, an account that generates 2.0% gross returns and pays 0.5% fees each quarter will generate a gross annual return of 8.24% and net annual return of 6.11%.