BMO’s Wolves in Sheep’s Clothing

Since Bank of Montreal entered the ETF business in May 2009, it has managed to grab only a tiny market share. Last week, however, BMO made a move designed to attract new investors to its ETFs. Ironically, it did so by packaging and selling them as mutual funds.

Following a unitholder meeting on September 13, BMO announced that it would make changes to its existing family of index mutual funds. These will now be known as the BMO Canadian Equity ETF Fund, the BMO U.S. Equity ETF Fund and the BMO International Equity ETF Fund. Instead of holding the individual stocks in their respective indexes as before, the three mutual funds will now simply hold one or more BMO ETFs in the same asset classes.

For example, instead of tracking the S&P/TSX Composite, the Canadian equity fund will now simply hold shares in the BMO Dow Jones Canada Titans 60 Index ETF. For now at least, it appears that the new mutual funds will also hold derivatives that promise the same return as the respective ETFs.

Many advisors can’t sell ETFs

What’s the point of wrapping up an ETF inside a mutual fund? Simple: it allows more financial advisors to sell them. Only advisors licensed by the Investment Industry Regulatory Organization of Canada (IIROC) are permitted to sell individual stocks. ETFs, even though they are diversified baskets of securities, are considered individual stocks by the regulators. Advisors who are licensed by the Mutual Fund Dealers Association (MFDA) — and there are many more of these — are not permitted to sell them. However, these advisors can sell mutual funds, even if those mutual funds contain nothing but ETFs. No, it doesn’t make any sense, but that’s how it works.

BMO is not the first financial institution to exploit this regulatory oddity. Late last year, Invesco Trimark packaged several PowerShares ETFs (which are listed in the US) in mutual funds for Canadian investors. R.N. Croft Financial Group Inc. also launched its line of PIE Funds, which each hold several ETFs and function as complete portfolios. The move isn’t even entirely new for BMO, who this past spring launched several Guardian Funds, which are also ETF portfolios in a mutual fund wrapper.

It appears that advisors are getting a lot of questions from clients, probably along the lines of, “Why can’t I use ETFs, since they’re so much cheaper than the mutual funds you use in my account?” Now these advisors can steer clients toward this new funds and say, “You want ETFs? You got ’em,” even if that’s not entirely true.

Unfortunately, BMO has not lowered the fees on its three equity index funds. Investors will still pay a 1% management fee or more for the newly branded mutual funds, compared with 0.15% to 0.46% for the underlying ETFs purchased directly. That said, this is a far better deal than what advisors’ clients are getting from actively managed funds or wrap accounts, where they’re likely paying over 2.5%. Indeed, if they’re now able to use index funds and get ongoing advice, they may be able to reduce their overall costs by more than full percentage point and get good value.

Does the term “ETF” mean anything?

Still, it’s hard to jump for joy over these new “ETF funds.” They’re not meaningfully different from BMO’s older, overpriced index funds. In fact, they now track less diversified indexes for the same fee. And they certainly don’t offer anything for do-it-yourself investors, who can get lower priced index funds from TD, RBC and Altamira.

What’s more troubling, BMO’s decision to rebrand its index funds smells like a marketing ploy. As investor advocate Ken Kivenko of Canadian Fund Watch explains, funds tend to change their names when they want to be associated with what’s hot, and right now ETFs are snowballing in popularity. “This appears to be the motivation here,” Kivenko wrote in a recent report, “building on the word ‘ETF.’ Mutual fund investors, the most vulnerable of investors, risk being fooled by these more expensive misnamed hybrid funds.”

In the end, I have to agree with Kivenko. “ETF” used to be synonymous with passive index investing. That hasn’t been true for a years: leveraged, inverse and actively managed ETFs are now among the most actively traded on the TSX. But until BMO’s move last week, at least the term always meant “exchange-traded fund.” No longer. Now, apparently, it can also refer to a mutual fund.

The waters are getting so muddy that you can’t blame the average investor for being confused.

7 Responses to BMO’s Wolves in Sheep’s Clothing

  1. Sean September 21, 2010 at 1:10 pm #

    Quite often, it’s not the advice that is “ongoing” only the management fees and trailer fees. For example all those people who buy “commission free” mutual funds through brokerages instead of directly from the company. Many brokerages don’t even list mutual funds that don’t pay trailer fees!

  2. Greg September 21, 2010 at 1:52 pm #

    This would be a good idea for people that prefer mutual funds if BMO passed the cost savings funds to the customer in the form of a reduced MER. I fail to see why someone should by this over Altimara Canadian Index fund (with a mer just over 0.5) which is also based on the TSX 60. This should be priced competitively with the e-series but it is not.

  3. Canadian Couch Potato September 21, 2010 at 2:04 pm #

    @Greg: You’re absolutely right if you’re talking about DIY investors. It makes no sense to choose these BMO funds over Altamira’s or TD’s if you’re buying through a discount brokerage. However, if you want to work with a BMO advisor and his or her compensation is included in the 1% MER, then you may well be getting good value. Certainly that would be better than working with an advisor who discourages indexing and wants to put you in a wrap account with fees two or three times higher.

  4. Greg September 21, 2010 at 2:18 pm #

    @CCP: So why not introduce a low cost series like TD did and offer it to investorline customers? I presume BMO will see considerable savings by managing the holdings for the ETF only. They even indicate in the press release that there will likely be cost savings (which is why I am surprised that the MER is not lower).

  5. Canadian Couch Potato September 21, 2010 at 2:28 pm #

    @Greg: I agree that would be welcome — or, as I’ve posted in the past, BMO could just offer Investorline clients free trades on their ETFs, which is what Vanguard, Schwab and Fidelity do in the US. I have to say, I would be seriously tempted to switch to BMO ETFs if offered that incentive. But I’m not switching just to save a few basis points in MER.

    Unfortunately, from the discussions I’ve had with TD and individual investors, the banks have zero interest in lowering costs and passing savings on to their customers. TD bends over backwards to discourage people from using their e-Series funds:
    http://canadiancouchpotato.com/2010/08/05/would-you-like-fees-with-that/

    I don’t expect any bank to create a product similar to the e-Series funds: they’re just not profitable enough.

  6. Chris September 22, 2010 at 10:57 am #

    It seems to me like a separate low cost mutual fund for for DIY investors would be redundant. DIY investors already have access to BMO ETFs (albeit with a commision) and those who prefer to work with an adviser now have access to the ETF mutual funds (with higher ongoing fees).

    I think the good thing about this strategy is that it has increased the capital base of three ETFs (while presumably lowering the overall costs incurred by BMO). One of the big questions about new ETFs is whether or not they will survive. Shouldn’t this increase that chance substantially?

  7. Greg September 22, 2010 at 12:54 pm #

    @Chris: I think for well off DIY investors a low cost mutual fund could very well be redundant. But, for those DIY investors that want to dollar cost average (its much easier on the budget), prefer a full reinvestment of distributions and do not want to play an active role in buying and selling, low cost mutual funds are a great way to go.
    Also, all BMO is doing is taking existing index mutual funds, tweaking the holdings to hold an ETF that holds the stocks instead of the stocks themselves and renaming it. Investors still had access to what was essentially a similar product before BMO changed the name. This does absolutely nothing for existing investors of those funds (and in fact changes the holdings of the Canadian equity fund) and I fail to see the advantage of this to the investor of the mutual funds. If you are going to pay a 1% MER may as well go to ING and save time by not needing to rebalance.

    Only advantages here are to BMO in the form of cost savings, stability of the ETFs and marketing spin.

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