There’s a mountain of evidence that shows investors shouldn’t hold mutual funds.
Mutual fund marketing has always claimed investors should pay the management fees, so they have a chance of beating the market. But with the average annual fee for Canadian funds north of 2%, these funds have to crush the market in order for investors to justify the fees. Over the long term, that’s virtually impossible, especially considering the size disadvantage most funds have to deal with. It’s hard to beat the market when you’re managing billions.
Besides, many funds are closet indexers, afraid to really stick their neck out because the consequences for getting the call wrong would be huge. Most investors won’t leave if a fund has a mediocre year, but many will if the fund underperforms badly. And as we all know, sometimes even the best stock picks struggle in the short term.
In the past, fund performance really didn’t matter since they were the only game in town. Investors either had to buy funds or pay huge trading costs for individual stocks. These days, investors can trade stocks for pennies per share and invest in exchange traded funds (ETFs) that charge less than 0.10% annually in fees.
That’s obviously not good for the purveyors of expensive mutual funds. But things are about to get even worse.
Rules are changing
In 2016 another nail will be put into the mutual fund industry’s coffin.
As it stands now, all a fund needs to do is disclose the annual expenses in a percentage form. Starting next year, it’ll have to tell investors exactly what they paid in dollar terms.
One of the reasons why the typical investor is in mutual funds in the first place is because they’re not very good at business or math. The appeal of having a fund manager take care of all that is half the reason why they’re in the fund in the first place.
During an up market, it’s fine. Folks are happy to pay fees if the value of the fund goes up. But if the market is down, there are going to be a lot of folks seeking lower-cost options.
How about the stocks?
Canada has three large companies that are primarily in the mutual fund business: IGM Financial Inc. (TSX:IGM), CI Financial Corp. (TSX:CIX), and AGF Management Limited (TSX:AGF.B).
Both IGM Financial and AGF have already been crushed by this news. Since the beginning of the year IGM Financial—which is the parent company of Investors Group—has seen its shares fall by more than 20%. The current dividend yield just surpassed 6%, and it trades at just 12.5 times earnings. The market is clearly sending a signal that investors have no confidence in the earnings being able to continue.
AGF Management is even cheaper. It trades at just nine times earnings as I write this. The big difference between IGM Financial and AGF is the latter doesn’t have an army of agents pushing its products. It has to use sales reps to try and convince investment advisors to push its funds. That’s not a good spot to be in a future where companies will be likely to push reps to recommend their own branded products first.
CI Financial might have the brightest future of the three. Firstly, CI has more exposure to the institutional market than the other two, which is viewed as more steady business. CI’s funds are also more niche in nature, often representing sectors where getting good ETF exposure is hard. And CI seems to be doing a better job embracing a fee-for-service financial planning model that the other two wealth managers are fighting with all their might.
Still, that’s not enough to make me bullish on the company. The whole wealth management sector in Canada is changing, and not in a good way for the incumbents. At a minimum, investors should at least see where the trend is going before hopping back into the industry.
