A price war has broken out in Canada over management expense ratios on no-load index funds. Several of the country's best known fund complexes, including two owned by powerful banks, have been taking turns undercutting each other.
Profit margins at the banks are among the early casualties. But in a market where consumer sensitivity to fees has been growing, the downward pressure on MERs also has industry-wide implications.
The price war was triggered by Royal Mutual Funds, the second largest fund complex and the largest no-load company. Royal Mutual is a latecomer to index funds. A subsidiary of Royal Bank of Canada, the country's largest financial institution, it appears determined to not only give its customers access to an increasingly popular product, but to offer the best price.
Royal initiated the first round of price-cutting in mid-October, when it introduced six new index funds with expense ratios that it claimed were the lowest in Canada. Four of the six funds are mainstream retail products, requiring minimum investments of $2,500 (Canadian) and carrying maximum expense ratios of 0.55 percent. The remaining two were "premium" funds with high minimum investments of $250,000, but with MERs of only 0.3 percent.
Initially, Royal promoted itself as offering the lowest fees in Canada and it did, for a time. Royal's MERs undercut by a wide margin those of its arch-rival CIBC Securities, whose parent CIBC is the second largest Canadian bank. CIBC Securities, whose $1.4 billion in index funds as of Oct. 31 make it the leader in market share in this segment , has set its MERs on all of its index funds at 0.9 percent.
But, Royal's claim to being the low-cost provider was short lived. It was undercut, in turn, by direct seller Altamira Investment Services. Altamira, the nineteenth largest firm, entered the index fund market in early November with three new equity funds. Investing in the Canadian, U.S. and overseas markets, the new Altamira funds each have MERs of half a point, or five basis points less than Royal did at the time.
Altamira's minimum investment of $5,000 was twice as high as that of Royal's four retail funds. But that minimum enabled Altamira to offer the lowest cost available to the "average investor," the company said.
Royal made a swift counter-move. The day after Altamira's announcement, Royal announced a fee reduction for its four retail funds in which it matched Altamira's MERs, while maintaining its lower minimum purchase.
"We are committed to being cost competitive and accessible," said Simon Lewis, Royal Mutual Funds' president and CEO, in announcing Royal would maintain its status as a price leader.
After Royal's fee cutting move, the index fund market reached an uneasy equilibrium. Canada Trust and TD Asset Management, the second and third largest companies in index funds with $1.2 billion and $1 billion respectively in retail funds, have made no competitive response to lower their fees.
Market leader CIBC also held the line, but only on its retail funds. Because of its success in gathering index fund assets, CIBC has the most to lose in the short term by cutting fees. At its current level of assets, matching Royal's and Altamira's MERs across the board would result in a reduction of fee revenue from index funds to $7.5 million annually, down sharply from $13.5 million.
Avoiding a full scale challenge to Royal, CIBC instead made a limited counter-move to appeal to corporate, institutional and high net worth investors. It announced on Nov. 26 a rebate on its index fund fees to large accounts. CIBC matched Royal's reduced MER for large purchases, but undercut Royal by offering its rebate at a lower threshold. CIBC's reduced MER of 0.3 percent applies to minimum balances of $150,000, compared with $250,000 at Royal. In addition, CIBC's rebates for accounts of more than $500,000 result in an effective MER of 0.25 percent, or five basis points less than Royal.
In the meantime, CIBC opened up another skirmish in the index fund market by launching a series of index funds, modeled on its existing funds but with capital protection guarantees. Called the CIBC Five-Year Protected Mutual Funds, they promise investors the return of at least their original investment after five years, regardless of how the funds perform.
Underscoring the difference between the insured funds and its regular index offerings, the CIBC Protected Funds include MERs of up to 2.95 percent for its international equity fund. That is more than triple the uninsured CIBC fund, and nearly five times as high as Altamira and Royal, the index fund price leaders.
Nonetheless, Ted Cadsby, the president and ceo of CIBC Securities, is saying his new series are the lowest cost funds available. He says the CIBC Protected MERs compare favorably with segregated funds sold by insurance companies, particularly since the maturity guarantee for segregated funds requires a minimum holding period of 10 years. (Segregated funds, similar to variable annuities in the U.S. but without the tax-deferral benefits, are a term used in Canada to describe policies sold by insurance agents that combine investment funds with insurance features.)
"We think we've really surprised the market," said Cadsby. "We've launched a very low fee guaranteed mutual fund family."