How do I unscramble the alphabet soup of mutual fund classes?
FP Answers puts your investing questions to the experts. This week Julie Cazzin talks with Allan Norman, an investment adviser with Aligned Capital Partners Inc. Whatever your investment question, ask us, because FP Answers.
Q I’ve been investing on my own for about a year now. But I’m still confused about the different types of mutual fund share classes. What do they all mean? And how do I go about choosing the right one for investments? — Thanks, Ida Marie
FP ANSWERS: Ida, I can understand why you are confused when it comes to the different share classes. There isn’t a standard classification system between fund companies, and I’ll bet almost every letter in the alphabet has been used to identify a different fund class.
If you’ve researched funds, you’ve likely seen the same fund listed more than once with different rates of return. Understanding the classification system will explain how the same fund can have different rates of return.
Mutual funds are generally classed based on their expenses and the benefits they provide to investors and advisers, and it is the different fund expenses that explain why the same fund can have different rates of return. The higher the expenses, the lower the return on even the same fund.
The common fund classifications are “A” and “F,” which are designed primarily for investment advisers. “D” class funds are for doit-yourself investors, and “I” class funds are for institutional investors.
A class funds pay advisers and/or their employer commissions, and they normally have the highest fees. As an example, if an equity or balanced fund has a management expense ratio (MER) of 2.5 per cent, and a trading expense ratio (TER) of 0.03 per cent, there is normally a oneper-cent annual commission, pro-rated monthly, paid to the adviser. This is referred to as a trailing commission.
In this case, a $100,000 investment in an A class fund has a total fee of 100,000 x 2.53 per cent, or $2,530, of which the adviser earns $1,000. The only fee that has to be reported on your investment statement is the adviser portion.
To find out what you are actually paying, it is best to look at a fund’s Fund Facts document to find the sum of the MER and TER and then multiply that by your total investments. A quick Google search should locate the Fund Facts, and the MER and TER are usually on page 3.
A do-it-yourself investor can purchase A class funds, but if you have the choice, don’t. Remember, A class funds pay an annual trailing commission of generally one per cent on equity and balanced funds, and 0.5 per cent on fixed income (i.e., bond) funds. Those commissions won’t be going to you. They either go to an adviser, if there is one, or the firm you’re investing with.
F class funds are designed for the fee-based adviser, one who charges fees based on your account size. Normally the MER on these funds is the same MER as the A class fund minus the adviser’s commission. Using a real-life example, an A class fund with a MER of 2.5 per cent has a corresponding F class fund with a MER of one per cent. This difference will vary between funds and fund companies.
Of course, advisers don’t earn anything with these types of funds, so they normally charge a fee plus HST, and fees often range in the range of one to 1.5 per cent. If you are wondering, HST is normally included in the A class MER.
Although F class funds are designed for fee-based accounts, there is no requirement to add a fee. Advisers add a fee because they are running a business and need some form of compensation. Without the fee, F class funds are a good low-cost option for DIY investors, if they’re available at the discount brokerage firm you’re dealing with.
D class funds are for the do-it-yourself investor and may be available at your discount brokerage. The MER on the D class fund used in the example is 1.59 per cent and a small trailing commission goes to the discount brokerage. Before purchasing a D class fund, check to
F CLASS FUNDS ARE DESIGNED FOR THE FEE-BASED ADVISER.
see if the F class version is available and compare the MERS. You may find that the F class fund has the lower MER and, if so, that would be the fund to purchase.
I class funds are for institutional investors and I mention them here because you may see them and wonder what they are, but you may also have access to them if you are working with a portfolio manager. The MERS in these funds are lower compared to the other classes.
One final piece of advice: If you’re still not sure which fund class to purchase, look at the fund’s Fund Facts and check the MER, TER and commissions paid, if any. Given the choice, the best fund class is the one with the lowest fees.