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Recently I was talking to one of my buddies that works in the world of agricultural finance (so he and his co-workers are familiar with many basic financial principles) and he asked me for my opinion on corporate class funds. I told him that to be honest, I didn’t know too much about what advantages they offered because I almost assuredly wasn’t interested in them seeing as how they were just mutual funds with a twist. He claimed that they were becoming all the rage in his office, and some guys were swearing by them. I decided to do a little research and educate myself on what the nuts and bolts of corporate class funds were. I wish I could say that I found a great investment opportunity, but unfortunately I’m fairly certain they are just another financial instrument cooked up the banking industry to separate you from your investment dollars.  Needless to say, I’ll stick with purchasing index ETFs through my discount brokerage account (see my Questrade Review) and my robo advisor TFSA.

Advantages… Kind Of

The whole idea behind the creation of these funds (alternatively known as “mutual fund switch corporations”) is for large-scale investors to be able to move in and out of certain mutual funds without triggering investment-related tax burdens. Essentially, certain companies will boast a menu of corporate class mutual funds, and investors can buy and sell these funds within that menu and defer your tax payments until it is most beneficial for you to realize the income (in the form of capital gains). The sales pitch behind this sort of advantage is that you might want different investing exposure throughout your lifetime, or you may want to rebalance your portfolio, and these “families” of mutual funds allow you to do that cheaply and efficiently. Personally, I’m not a huge fan of planning investments around tax liabilities to begin with (see Young’s experience with flow through shares), but there is no doubt that tax effectiveness is a huge part of your overall financial plan; therefore, I can see how a creative salesman could market corporate class funds in a slick manner.

Problems With Corporate Class Funds

Here is the myriad of problems I have with the whole idea of these funds. First and foremost, these investments make absolutely no sense unless you have maxed out all of the room in your registered accounts. These unique funds almost always have a higher MER rate than their regular mutual fund little brother, and consequently you could simply buy the run-of-the-mill mutual fund and put it in your RRSP/RESP/TFSA and get the same benefits for a lower MER percentage. That being said, in defence of corporate class funds they don’t really claim to be for the average investor. Just so we’re clear, they are utterly indefensible in my mind if you still have room in your registered accounts (and hey, if you’re maxing out your RRSP/RESP/TFSA every year, then you’re further ahead in the game than I am to be brutally honest).

The second problem I have in principle is not solely with “mutual fund switch corporations”, but instead with mutual funds in general. I can’t stomach the idea of most mutual funds saying that they will outperform the market because there is simply no academic evidence to balance this out in the vast majority of cases. Most mutual funds don’t beat the market BEFORE fees are calculated in. When you factor in the 2.1% MER fee average in Canada, less than 1% of mutual funds beat the market average over an extended period of time, and corporate class funds usually add another .2%-.4% of fees on top of that! It just doesn’t add up no matter what your advisor tells you.

The final issue I have with the concept of being able to switch mutual funds at will within a certain menu is the idea that you want to switch mutual funds at all. This marketing is aimed specifically at the sort of investor that believes they can outsmart the market by timing certain trends and picking the right stocks/funds. My guess is that these funds are disproportionately owned by males because of that very reason! I can see how it makes a certain degree of sense if you simply want to rebalance your portfolio, or gradually move into a more conservative asset allocation over a decade or something like that, but I would bet that the majority of trading back and forth is part of speculation and not much else.

KISS – Keep It Simple Stupid

No matter what tax advantages corporate class funds can offer me I can’t say I’m very interested due to the fact I have no faith in my ability to pick mutual funds, or mutual fund managers’ ability to choose investments for the long term. Once again, it bears repeating that I would never advise anyone to look at these investment vehicles if they still had any room left in their registered accounts. Obviously I am still partial to ETF/passive investing inside of registered accounts as the first course of investments. After that you are dealing with unregistered investments, and if you truly believe you can avoid enough taxes to offset bad mutual fund managers and MERs that reach into the 3% range, then be my guest. As long as you’re maxing out your registered accounts, you’ll be just fine in the long run anyway. I would argue that even in your unregistered accounts you’d likely be better off just throwing darts at list of TSX and NYSE stocks and investing in them for the long term, or specializing in a Canadian-dividend specific strategy while balancing your international exposure in your registered accounts.

Article comments

Jason says:

I ended up here doing research on corp class funds because I have a holding company that holds assets and earns a management fee. I have contribution room in my rrsp and tsfa but I can invest money inside of my holding co. And take advantage of small business tax of 15% effectively investing with 85 cent dollars instead of 60 cent and defer my taxation indefinitely while still being able to rebalance.

I’m not 100% on the numbers but it seems like this method is better than investing in an rrsp or in a tsfa?

Kyle says:

Now that is an interesting situation Jason. Here’s my thoughts when you make an excel sheet to figure this out:
-Take a look at the average performance of corp class funds over the last several years (on average – brutal)
-If I understand the structure of holding companies properly, you will have to pay the taxman eventually when you liquidate the assets won’t you?

Craig says:

Im a CFP and CLU in canada. I use wealth simple as my main investment partner, so I have no bias to funds.

Corporate class funds can no longer be switched between funds.

Corporate class funds also change interest income and dividends to capital gains, this is huge for non registered accounts.

Corporate class funds also keeps incorporate business accounts from recoginzing passive income, which is a whole other story. Interest income inside a business, when said and done and paid through to the share holder can get over 60 percent tax, and claw back your small business deduction. (in Canada) More expensive corporate class funds can prevent all of this. And through very advanced financial planning (not investment planning) can mitigate a lot of the capital gains when it is time to recognize them.

Corporate class also is the most efficient at using a RETURN OF CAPITAL product. This is when the fund gives you your money back instead of the growth. Once the ACB is zero than your withdrawals are capital gains and not dividends or interest.

Corporate class structures are required for international investments. You international ETFs, are paying the foreign taxes, or your platform is depending on the currency you bought etc.

There is much more going into it than what you read on the interenet.

ETFs are great for day to day, CorpClass is great in non-registered

Jim R says:

Craig and/or Teacher Man,
Do you have an opinion on Horizons’ total return, corporate class, index ETFs (e.g. HXS, HXT, etc)? Previous to 2020 these were pure swap based, index ETFs that converted interest and dividends to capital gains. CRA tax changes disallowed the use of swaps for this purpose, so Horizons switched the ETFs to corporate class ETFs and facilitated a section 85 rollover for unit holders of the ETFs (FWIW, I had shares in HXS and HXT and did the rollover). The MER for these reclassified ETFs is about 0.10% (which beats mutual funds by a cosmic mile), *but* there is still a swap fee of 0.30%, bringing the total to about 0.40%.

My big concern is that the CRA will set its sites on corporate class MFs and ETFs and disallow the tax advantage they enjoy. If this a legitimate concern? If so, what’s the likelihood?

The fact that only Horizons offers corporate class ETFs also concerns me. Why aren’t we seeing Vanguard, Blackrock, etc doing the same?

Robb Engen says:

Hi Jim, I spoke with Vanguard’s head of product sales in Canada and asked him specifically about Horizons’ total return index ETFs. He said, and I quote, “we prefer to hold securities directly.”

You’re absolutely right that investors will take on “regulatory risk” when investing in these products because the tax loophole could be closed at any time. The federal government did mention this last year but never followed through with any changes.

As Craig says, these products do make a lot of sense in a taxable account (when your registered accounts are maxed), but there are certainly some future unknowns to consider.

Jamie says:

I have maxed out RRSP + TFSA contributions for 4 years, and with a 40:60 split of fixed income:equity, I have no choice but to locate fixed income in my non-registered investment account.
It sounds to me like Corp class MF’s are a good way to go. I am a passive, buy-hold ETF investor. Does anyone have any recommendations on similar index-based, inexpensive Corp Class MF products? Do they exist?
Many thanks for the discussion.

Teacher Man says:

I highly doubt the tax benefits will offset the difference in MERs you’re going to pay, but I guess it makes a little more sense if you’re maxing out your registered accounts.

craig says:

They do,
in the right situation you can be deffering over 50% tax,

that worth the 2%,

ETF and funds have more planning than fees, accounts type etc.

Bbob says:

Hit the nail right on the head Frank, I couldn’t have said it better myself.

Frank says:

Hi teacherman,

Thanks for writing the article. What Bbob wrote is absolutely true – the biggest misconception of CC funds is the ability to switch between funds being the biggest benefit. This is nice for an accumulator who is decreasing equity as they approach retirement (or a ‘fund trader’ if there’s such a thing), but the real benefit is the re-classification of interest income. The mechanism that’s usually used for this is a forward contract, which costs anywhere from 30-60 bps, but generally speaking if you’re in a tax bracket over 30%, and the yield on the portfolio is roughly above 2.5% then the tax treatment of capital gains outweighs the cost of doing the swap in the first place (people hear ‘forward’ and assume it’s risky – the only real risk outside of market is counterparty risk, or the company doing the swap going under).

One other benefit that wasn’t mentioned is reducing the likelihood of a year-end distribution from the funds. Since the corporation can offset interest and cap. gains with the actual fees of the pool, they are often able to avoid paying year-end distributions. It isn’t a guarantee, but if you look at the historical distributions of CC funds vs. trust units for some of the big 3rd party fund cos., it happens much less frequently.

One last general comment, there are a lot of crappy mutual funds out there that never outperform the index. However, there are a lot of really good ones with great track records. There are also a lot of good funds that are very reasonably priced. Unfortunately, there are more poor performing, high priced funds out there than there should be, and they tend to give the whole group a bad rap. The whole active vs. passive argument can be made over and over, but I think both provide benefits depending on what you’re looking for, and I wouldn’t write off either.

Teacher Man says:

You’re definitely right on the other benefit there Frank, that just gets pretty technical for the average investor, and I’d be willing to bet a large majority of retail investors that get sold on CC funds aren’t doing it for the relatively small year-end distribution savings. I would tend to disagree that there are “a lot of really good ones” when it comes to mutual funds. Check out my free ebook for the complete John Bogle-inspired argument as to why less than 1% of mutual funds are worth it, and good luck identifying those!

Bbob says:

Hi teacherman,

Thanks for your article, but I feel that it is a l title bit one sided. You went into your research with a n evasive attitude considering your feelings on mutual fund trusts, and I believe it caused a self-full filling prophecy. Firstly, corporate class funds when they 1st came out in the late eighties had a higher fee attached to them, but over the past few years, they have almost all come down to be the exact same cost as their mutual fund trust counterparts (check any CI fund). Secondly, you neglected to mention the main advantage of corporate class funds of transforming any interest or dividend distributions into capital gains, and only realized upon distribution. So if I am looking at an investor that has a bias towards bonds and dividend paying stocks, I can effectively defer all taxable distributions outside of a registered plan, and when they are realized, it is as a capital gain. At the highest tax bracket, you pay 48% tax on interest received, 36% on dividends, and 24% on capital gains. So if you have a bond in todays low interest rate environment, you can hold a tradition individual bond yielding 4% and be left with 2% after tax, or by using a corporate class fund, if you do not need the money, the whole 4% stays invested and when you sell the bond, you are left with 3% net of taxes.

In any ways, I am not trying to convince anyone for or against funds, but a truthful description would help.

Teacher Man says:

Hey Bbob, you definitely raise some slight oversights in the article. I did mention the tax advantages (although I was definitely a little vague on the specifics) that corporate class funds do bring to the table. Again, for the vast majority of investors this is irrelevant since they will never max out all of their registered accounts. I did allow that one might receive some benefit from CC Funds in a certain situation. The bond comparison you make is absolutely legitimate. I hardly know anyone at all except for ultra high networth clients that would leave bonds outside of a registered account, but I’m sure there are a solid number out there (although probably not reading this site).

As to my preconceived bias, you are definitely correct there as well, although I would argue that it is a bias rooted in fact. Saying that CC funds are bringing fees down to the level of the average mutual fund in Canada isn’t saying much for them. MER fees in this country are absolutely ridiculous, and I would argue (with the help of guys like John Bogle) that any advantages CC funds have are more than wiped out by the variety of anchors that weigh down the entire mutual fund industry.