Fees are a standard component of the investment industry, spanning both asset management and advisory services. These fees represent the cost incurred for the investment expertise, operational administration, and ongoing financial service you receive. Since these costs are generally calculated as a percentage of your invested assets, they have a direct impact on your net return. Like anything we spend our hard-earned money on, it’s important to have a clear understanding of the components and structure in order to make informed decisions. 

In this article, we’ll break down the different fee components that make up the management expense ratio (MER) of a mutual fund and exchange-traded funds (ETFs) and show how this differs between two common mutual fund series—transactional and fee-based. 

Understanding the cost of managed funds

When you invest in managed funds like mutual funds or ETFs, a predominant component of the costs are captured in the MER. While ETFs typically have lower MERs, mutual funds offer different series structures that determine how you pay for the fund’s management and your advisor’s ongoing service.

The management expense ratio

The MER is the total cost of running a fund, expressed as an annual percentage of the fund’s assets. It is an embedded cost that is automatically deducted from the fund's assets which means that the posted returns of a fund are after fees have been considered.

The components of a fund’s MER vary depending on whether you are in a transactional or fee-based series fund. 

Transactional series mutual fund

The MER of a transactional series mutual fund is composed of the following:

1. The management fee:
   1. Investment management fee, which covers professional investment management, research, and general fund administration.
   2. Trailing commission or trailer which is collected by the fund company and paid back to the dealer firm as compensation for selling the fund. The trailer helps the dealer firm cover costs including back-office support and compensates advisors for the advice and on-going services they provide to their clients.
      
      
2. Operating expenses: Covers day-to-day costs of the fund company like record-keeping, legal, and auditing fees.
   
   
3. Taxes: Each fund is required to pay taxes on its management and administration fees.

Fee-based series mutual fund and ETFs

The MER of a fee-based series fund and an ETF include the same components as a transactional series mutual fund except the trailing commission or trailer.

Instead of the trailer being embedded in the MER, it is stripped out and replaced by an advisory or account fee charged directly by the dealer firm offering the fund. This provides the dealer firm with flexibility in how it charges clients for the cost of advice and service.