Anyone flipping through a prospectus for an employer’s defined contribution pension plan or group registered retirement savings plan will notice a recurring theme when it comes to statements on investment fees: “Better than retail!” they might as well scream.
It’s a familiar refrain from both capital accumulation plan sponsors and providers trumpeting the lower rates available with group offerings, but it doesn’t do much for Michelle Loder, partner in DC solutions at Morneau Shepell Ltd. “It’s a very low bar to clear,” she says. “There’s not much cause for celebration when you realize that Canada is one of the worst places in the world for retail investment fees. The Canadian model — and this is true in both the retail space and the institutional space in many cases — is to pay a single fee for a bundle of services, which allows other fees to be hidden in those amounts.”
According to Morningstar Inc.’s 2019 study of global mutual fund markets, Canada’s asset-weighted median expenses came out on top for most of the asset classes covered by the report. For allocation funds, Canadian investors pay an average of 1.94 per cent annually, more than three-times higher than their U.S counterparts, where the figure was 0.6 per cent. Meanwhile, the charge on the median Canadian equity fund stood at 1.98 per cent, compared with 0.59 per cent south of the border.
Those numbers played a large part in Canada’s below average grade, ahead of only Italy and Taiwan in the survey of 26 countries. And that actually represented a marginal improvement on the 2017 findings, when the Canadian medians stood at 2.02 per cent for allocation funds and 2.23 for equity, earning the country a place in the study’s bottom spot.
Room for improvement
Such a high retail baseline leaves plenty of room for improvement for DC plan sponsors seeking the best deal for their members in terms of investment fees, says Loder. Among her own plan sponsor clients, the average fee stands at less than 0.7 per cent of assets under management or 70 basis points.
By the numbers
$13.5 million — Amount paid to U.S. Walmart Inc. pension plan members in 2011 to settle claims that its DC plan negligently picked retail class investments over cheaper institutional options
0.75% — The U.K.’s annual charge cap for auto-enrolled DC plan members
0.38% — The current management expense ratio for the Co-operation Superannuation Society pension plan’s balanced fund
25% — The amount by which a 1% annual charge can deplete a member’s total pension pot over the course of 40 years
But larger plans can leverage their purchasing power to negotiate even lower fees, she adds, noting a DC plan in excess of $100 million could be looking at investment fees below 20 basis points. “Record keepers will market products available to plan sponsors as better than retail, but if the fees are not significantly better, then they will warrant closer examination.”
In fact, Terra Klinck, a senior pension lawyer and founder at Brown Mills Klinck Prezioso LLP, says fees play a key part in plan sponsors’ fiduciary duties, requiring that they make decisions in their members’ best interest. “The employer needs to select a prudent range of investment options and the level of fees is one factor to be taken into account, along with performance, investment objectives of the plan and a whole list of other criteria.
“No one factor will be determinative, but fees are an important one, particularly with DC plans, because of the direct impact they will have on the member’s balance at retirement. Monitoring fees and looking at the market from time to time to see if they remain competitive is also an important part of their ongoing duties.”
While investment fees are also a significant concern for defined benefit plan sponsors, Klinck says the fiduciary relationship is more straightforward because employer and employee interests are so directly aligned. Since investment fees come out of the plan’s returns and DB plan sponsors are responsible for covering any shortfall, they have an intrinsic motivation to get the best deal they can.
“To the extent that fees can be reduced while returns remain the same, that’s ultimately going to result in a saving for the employer.”
Colin Ripsman, president of consultancy Elegant Investment Solutions Inc., says it will always be difficult for a DC plan to achieve a level of fees as low as a similarly sized DB plan. “It doesn’t necessarily mean they’re getting worse value, because there is more administration needed in a DC plan. Record keepers need to be able to keep individual records, communicate with each member and provide them with their own statements. It’s a labour-intensive process.”
Fees are the single biggest contributor to low DC pension savings, says Randy Bauslaugh, leader of the national pensions, benefits and executive compensation practice at McCarthy Tétrault LLP, who recalls a 2012 presentation that drove that message home.
Speaking at a pension conference, Chris Daykin, the U.K.’s former chief actuary, showed how the compounding effect of a one per cent charge on funds under management can reduce a person’s overall pension pot by as much as a quarter over a working lifetime. Meanwhile, a charge of two per cent depleted the fund by almost 40 per cent over the same period.
At the time of Daykin’s presentation, the U.K. was in the early stages of an overhaul that culminated with a 0.75 per cent cap on investment and management fees for DC plans with auto-enrolled members after a government report found hundreds of thousands of members were overpaying for services.
• Canadian retail investment fees are among the highest in the world, so it isn’t such a boast to claim
a group RRSP or DC pension plan gets better rates.
• Market competition and increased plan sponsor engagement have helped drive investment fees down in the last decade.
• Canadian plan sponsors have so far avoided investment fee lawsuits, but excessive choice and high decumulation fees pose potential future fiduciary risks.
The threat of a similar move never materialized in Canada, at least in part because competitive pressures in the last decade have driven investment fees down without the need for regulatory intervention, says Tom Reid, senior vice-president of group retirement services at Sun Life Financial. “As fees came down, [the industry has] innovated and become more automated. It’s a bit of a virtuous circle that allows fees to continue to drop.”
He says the focus of his conversations with plan sponsors has switched from absolute cost to value. “A lot of plan sponsors are developing great programs, but if they’re not getting plan members to engage, then the plan member does not fully appreciate the proposition that the sponsor has put together.”
Ben Homsy, a fixed income portfolio manager at Leith Wheeler Investment Counsel, senses the era of fee compression may be coming to a close and says he’d welcome a greater focus on value. “I think, as a whole, the industry benefits from competition. But if it’s purely in the form of offering lower fees through comingled assets, without necessarily providing benefits through superior risk management, then at the end of the day, clients aren’t really benefiting.
“Unfortunately, we have a tendency to evaluate decisions based on outcome, but you could have two investment managers with exactly the same performance numbers, except one of them has exposed their client — unbeknown to them — to a significant amount of risk.”
Engaged plan sponsors
Martin McInnis, executive director of Saskatchewan’s Co-operation Superannuation Society pension plan, says the $4-billion fund has built a reputation as a low-cost provider over its 81-year history, which may explain why members placed fees among their top three concerns in a recent survey.
Still, he says the plan doesn’t simply pick the cheapest option when searching for outside investment managers. “We’re not afraid to spend on behalf of our members, but we’ll only do so if we’re capturing value for money. Because of our size, we can seek out opportunities that members may not otherwise have access to at a reasonable cost.”
Other factors have contributed to the compression of investment fees in Canada, says Ripsman, including the highlighting effect of a low-return environment and even the economy-wide flight from DB to DC by plan sponsors seeking cost certainty. That has had a knock-on effect among investment managers, forcing them to broaden their appeal, he adds.
“With fewer DB plans, they’ve had to get out of the DB business, which was historically their bread and butter, and try to create relationships in the DC world.”
Engaged plan sponsors are also playing their part, says Bauslaugh, noting a spate of class-action lawsuits in the U.S. — numbering in the thousands over the last decade — alleging excessive investment charges helped sharpen their focus on the issue. “I’m always surprised there hasn’t been more litigation in Canada around DC plans and expenses.”
But that could change in the future as Canada’s DC market matures, he adds.
Fees in the decumulation stage is an increasingly dangerous blind spot for many employers, says Loder, noting all the hard work of fee optimization in the accumulation stage can be quickly undone by a plan member’s exposure to expensive retail products after retirement.
“There are two key decision points for members of a CAP program. I think we do a fairly decent job on enrolment of giving people information about the plan and helping them understand the financial impact of their decisions. But on departure, there tends to be a more hands-off approach from CAP providers. The differential in outcomes can be up to 30 per cent in income or anywhere between five and seven retirement years.”
While more plan sponsors are addressing the issue by developing their own in-plan decumulation options, Loder says warning lights should begin flashing if the assets of terminated plan members default into suboptimal registered retirement income funds or annuities offered by the same record keeper that’s running the DC plan.
“From a fiduciary perspective, you could argue that sponsors must make decisions in the best interests of all members, which includes those who are no longer active in the plan.”
When employers are doing everything they can to keep fees low, they shouldn’t be shy about letting their members know, says Ripsman. The compounding effect works both ways, turning even small improvements in the level of investment fees into significant asset gains over the course of an individual’s career.
“It’s important to communicate and help people understand the value of what they’re getting.”
Michael McKiernan is a freelance writer.