Performance Cost Ratio should replace the Management Expense Ratio (MER) to Compare Funds

When selecting a mutual fund to invest in one of the considerations is its Management Expense Ratio or MER. This is presented to investors as a way to compare different funds but it has some serious flaws. A different measure called the Performance Cost Ratio is a better option for directly comparing different Funds.

Now I know many Baby Boomers are in Company Retirement Plans and are in a default balanced portfolio of funds. So probably have very little idea of what MER is or why it is important – or not. Other Baby Boomers will often allow their financial planner to select the funds they invest into and trust them to do the right thing.

In my own case I allowed my financial planner to do just this and didn’t even question what funds I was invested in never mind what the MER was.

According to a report “The Trouble with MER” by Nigel Finch from the Macquarie School of Management, the MER is perhaps the major determinant in selecting one fund over another for investment purposes. But it has several major problems least of which is there is no consistency across funds as to what fees image and charges are included in the MER for each fund.

Before the advent of boutique funds and specialist funds the vast majority of funds were large and some agreement was reached on fee disclosure and the MER.

But now there are a high percentage of funds that are of the boutique or specialist type and they had not standardised on their fees at the time of this report. I don’t have information as to the status of this today unfortunately.

In Australia the product disclosure statement contains the information on fees and charges. But this does not show the actual fees payable, just estimated fees based on a possible investment amount.

Mr Finch considers this totally inadequate because it often does not include all the many types of fees that can be charged. He cites 17 unique fees charged as a flat fee or as a percentage of funds invested. I’ll say that again 17 separate fees.

One major point of concern is the focuses on the investment managers fees, number 4 on the list. This is often made the focal point of any fee disclosure rather than the total fees.

One major problem is the definition of fees and costs. Fees are visible and charged to the client. Costs are taken out of the fund as a whole. This means the more charges that can be made as costs against the whole of the fund, the lower the fees supposedly charged to the client and the cheaper the fund is when comparing it to other funds. This is grossly misleading.

Any charge against the fund or the clients investment in the fund results in a reduced return on that fund to the client and as such is a fee by any other name. The result is the same whether it is classified as a cost or a fee. The benefit to the fund though is they can hid a cost from their clients.

This has resulted in many funds reassigning fees as costs and promoting themselves as low fee funds. Many claim to have lowered their fees when in fact they fees have just been re-allocated as costs.

The Performance Cost Ratio is presented as a way to directly compare funds using a method based on absolute investment performance and recognising ALL fees and charges after tax. The idea is to make fees fully visible to an investor and allow them to directly compare funds.

This is even more important now that Australian workers can switch from their company superannuation fund to a fund of their choice. They need a reliable tool to do this.

The MER is not that tool. So if your financial planner uses it to compare funds let him know you know it to be unreliable.

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