Rushing For the Wrong Exit?

As of late, the stock market volatility has spooked many investors. Unfortunately, their fears are playing well into the game played by balanced funds’ portfolio managers, which is based on an assumption that balanced funds limit market risks by nicely packaging stocks and bonds in one cohesive mix.

The only problem with this concept is that it comes at a hefty price. It is designed to exploit the fears of many investors with promises of safer investments. And, as it turns out, many Canadians took that promise to heart. So far this year, balanced funds have become a “must have” item in most portfolios.

Allow me to illustrate just how high the price of a balanced fund is in comparison to its “peers.” For example, top ten Canadian bond fund charge on average management fees of about 1.82%. (There is a reason why bond funds are cheaper. They run almost on autopilot.) In contrast, top ten Canadian equity funds charge 2.33% for the same thing.

Logically, balanced funds, if these were a true mix between stocks and bonds, should be somewhere in between, depending on the mix. Instead, the management expense ratio (MER) on top ten Canadian balanced funds is much closer to stock funds, but on the other side of the range, averaging 2.49%.

One among the more popular Canadian balanced funds has about 60% in stocks and about 30% in bonds, with the rest staying in cash. So, while 40% of the fund consists of stuff that is much simpler to run, the fund still charges an obscene MER of 2.32%. In contrast, an equity fund within the same fund family charges 2.02%.

And, how did the mutual fund company justify this discrepancy? Well, apparently, servicing a balanced fund involves much more work than running a pure equity fund. When asked about the 40% of the portfolio that runs on autopilot, the portfolio manager said something not easily translatable into plain English.

The way I see it, balanced funds cost an arm and a leg simply because! And, while other types of funds have smartly decreased their MERs, balanced funds stubbornly refuse to budge. The end result? Investors are basically paying for the privilege of saying that they own a fund that is supposedly safer then all others.

Well, here comes a wake up call. Just because an investment vehicle is expensive, it does not mean it is risk-free or even risk- limited. If almost two-thirds within a fund consist of stocks, the fund buyers are not insulated from market volatility.

In other words, if you bought a balanced fund for the promise of a safer investment, then think again. You are still buying into a promise, not a guarantee, which makes the fees charged on balanced funds unjust and feeding on legitimate investors’ concerns.