Bargain hunting

Zoomer | August 5th, 2010

I recently appeared as a witness before the Senate Committee on Banking, Trade and Commerce which was studying the use of RRSPs and TFSAs for retirement savings.

After my opening remarks, there were a lot of questions from committee members. One of the issues that was addressed repeatedly was the cost of investing in mutual funds. The senators were concerned about high MERs and the degree to which these expenses were reducing returns over a lifetime of investing. Some of them asked me to compare ETFs with mutual funds from a cost perspective. Having read the transcripts from previous sessions, I was expecting this line of questioning as it was obvious several committee members were looking for ways to reduce these expenses.

The senators are right on the money about the extent to which high MERs reduce returns and, ultimately, the amount of capital a person has in an RRSP at retirement age. For example, suppose a 30-year-old invests $10,000 in a mutual fund with a 2.5 per cent MER (management expense ratio) and holds it until age 65. (Yes, that it improbable but this is only an illustration.) The total cost, compounded, over the 35 years is a staggering $23,732! If the person had bought a fund with a 1 per cent MER, the cost is still high at $14,166 but that is almost $9,600 cheaper.

The mutual fund industry vigorously disputes it but most independent experts believe that, with a few exceptions, the MERs charged on our funds are excessive.

Certainly, it is worth taking a close look at the MER before you make an investment. If a fund has a long track of outperformance, you may choose to accept a high MER but at least you’ll be aware of what you are paying.

With the concerns of the Senate committee fresh in my mind, I decided to go shopping in the bargain basement of the fund store to see what I could find. I was looking for mutual funds and ETFs that offer the best combination of low cost and consistent high returns. I limited the search to funds that are widely available to the general public and which did not have a prohibitively high cost of entry. F-class units were excluded because their MERs are lower by definition. Here are the two funds that stood out among actively-managed Canadian equity funds.

Winner: Sceptre Canadian Equity Fund (A units). The Sceptre organization has fallen off the radar screen of most investors, in part because the Toronto-based boutique house no longer has any superstar funds in its line-up. But the company offers several high-quality, low-cost entries. And for residents of Ontario, B.C., Manitoba, Saskatchewan, and New Brunswick they come with the added attraction of no load fees if purchased directly from Sceptre.

Sceptre Canadian Equity focuses mainly on large-cap stocks (e.g. big banks, RIM, Manulife) but also has a small/mid-cap component through a 12.5 per cent position in the companion Sceptre Equity Growth Fund. The management team takes a conservative approach using both value and growth criteria to select securities. This is not a fund that is normally subject to high volatility, although like all equity funds it was hit by the market plunge of 2008-09, losing 41 per cent in the year to Feb. 28/09. It has rebounded well, however, and has regained much of that ground.

Long-term results are well above average for the Canadian equity category. For the five years to May 31, the fund posted an average annual compound rate of return of 6.7 per cent, well above the 4.4 per cent average for the peer group. The MER is 1.69 per cent and the minimum initial investment is $5,000. The fund code for the A units is SIC007.

Runner-up: Mawer Canadian Equity Fund.. This one has been on the Recommended List of my Mutual Funds/ETFs Update newsletter since January 2005. Under the direction of Jim Hall, the fund offers a mix of large and mid-cap stocks with a few income trusts tossed in, such as Cineplex Galaxy Income Fund.

Hall took on the portfolio in 1999, first as co-manager and now as lead manager, and the fund has been an outperformer ever since. It generated an average annual compound rate of return of almost 8 per cent for the 10 years to May 31, just about double the category average. Results over all other time frames of one year and more are also above average.

The portfolio composition shows 41 per cent of the assets in financial services stocks and 19.5 per cent in energy, so these two sectors combined make up more than 60 per cent of the total. Major holdings include Royal Bank, TD Bank, Scotiabank, Power Corp., and Saputo. The long-term safety record is much better than average for the peer group.

The MER is a low 1.26 per cent. The fund is no-load and the minimum initial investment is $5,000. This is a good choice for an RRSP.

Ask your financial advisor if either fund is suitable for your needs.

Adapted from an article that originally appeared in Mutual Funds/ETFs Update, a monthly newsletter that provides advice on fund selection and strategies. For subscription information: click here.

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