24 February, 2020 Investment Services

How Investment Compensation & Fees Work

Retired couple reviewing investments with advisor.

RFP, MER, ETF, OAF, REIT: When it comes to your finances, there are all sorts of acronyms for specific account types, interest rates or savings plans. But what do they all mean?

 

Acronyms are helpful for those well-versed in the financial world, but can be confusing for those who aren’t immersed in it on a daily basis.

 

You may have heard of the term “MER,” and you may know that it refers to a “Management Expense Ratio.” In this post, we’ll take a closer look at how these compensation fees are calculated, exactly what costs are included in your MERs, and how your advisor earns their compensation through them. 

 

Our goal is to give you a clear idea of what sort of value you can expect to receive when paying this fee. 

What is a Management Expense Ratio?

A Management Expense Ratio (MER) is a ratio, expressed as a percentage, that reflects how much of your mutual fund holdings are deducted annually to cover the operating expenses of the fund.

 

In simple terms, an MER represents the costs associated with managing and operating a mutual fund. These costs can be anything from manager and staff salaries to dealer fees, office expenses, and taxes.

How is the MER calculated?

MERs are paid annually as a percentage of a mutual fund’s assets. Typically, this percentage is between 1–3%, but it can be higher depending on the fund. 

 

These fees are deducted before your return is calculated. While you don’t pay these expenses directly, they affect you because they reduce your returns from the fund. This can add up over time.

How do the costs vary?

Your mutual fund’s MERs can vary depending on the complexity of managing the fund. 

 

For example, bond mutual funds typically have lower research and trading costs, which means their MERs are lower. But if you have a global equity mutual fund, these costs increase — along with the MERs. 

What costs are MERs made up of?

The fees and costs within an MER can be broken up into five different parts.

1. The Management Fee

This fee covers a variety of costs:

  • Hiring portfolio managers at your fund company who make your investment decisions through fund research, selection and monitoring. 
  • The optimization of your portfolio through market research and analysis. 
  • 2. The Advisory Fee

This fee includes compensation for your advisor and the dealership they work with and can be broken down into three parts: 

  • Paying your advisor with a “trailing commission” — This is a fee paid to your financial advisor each year that you own an investment. This commission’s purpose is to give advisors an incentive to review your holdings and give you advice — but on the basis of increasing your wealth. Basically, it’s a reward for your advisor because you stayed with a successful fund. 
  • Planning for your future — Beyond advice, your advisor also goes through robust planning for your financial goals — which, of course, involves investing in mutual funds.
  • Servicing your accounts — Quite simply, this is the work that happens “behind the scenes,” after your financial advisor has consulted with you. This involves opening and closing accounts, purchasing new funds, or optimizing your current funds.

3. The Fixed-Rate Administration Fee

Otherwise known as “operating expenses,” the fee for administrating your mutual fund is a fixed fee that covers: 

  • Auditing your mutual fund statements — Each year, an independent auditor is paid to review your fund’s statements to ensure everything is correct.
  • Keeping your funds safe with a “custodian” — Every mutual fund has a “custodian,” which is a term for a trust company, bank or similar financial institution which is paid to hold and safeguard your assets. The custodian also acts as a third party to reduce the chance of fraud.
  • Updating you with account statements and reports — The fixed-rate fee also covers the printing and mailing of semi-annual account statements, reports and prospectuses, so that you’re kept up to date with everything that’s happening.

4. Other Fund Costs

A very small portion of the overall MER is made up of expenses such as:

  • Paying costs associated with interest or borrowing.
  • Preventing conflicts of interest — In Canada, all mutual funds are governed by an Independent Review Committee (IRC) that’s responsible for identifying and preventing conflicts of interest. 

5. Applicable Taxes

Depending on the province, a variable tax rate is paid on all of the fees listed above. To learn more about how these taxes are calculated, speak with your advisor.

How does my advisor earn money from an MER?

The chart below illustrates how a typical equity fund with an MER of 2.5% and an advisor trailer fee of 1% breaks down.

 

For example, if you invested $10,000 in this fund, you would pay $29 in taxes, $2 in other fund costs, $25 in administration costs and $231 in management fees, which includes dealer and advisor compensation.

 

 

Source: "Making Sense of MERs"

 

As you can see, the costs associated with the mutual fund are minimal. These costs are important as they ensure you receive full value from your investments through optimizing your portfolio, planning, auditing and safeguarding your funds.

 

If you’d like to find out more about MERs, the costs of investing or the costs of working with an advisor, contact us today.