Change is (hopefully) afoot: Mutual fund investing in Denmark

October 28th, 2014

Since the 2008-2009 stock market crash the humble Danish investor has been shying away from the comparatively time-demanding and risky business of purchasing individual stocks, instead doubling their investments in mutual funds over the past half decade.

With mutual funds come various fees, and while the U.S. stock market has an enormous market for low-cost passively managed index funds, these are nowhere near as popular in Denmark. Here, financial advisors have been very adept at steering investors towards funds under active management, funds which try to beat their benchmarks by picking stocks and rebalancing portfolios, even though these have historically provided long-term returns that are no better than passive index funds, where managers simply aim to follow the market.

So why not just advise investors to put their money in index funds? Because index funds have no intention of beating their benchmarks and so demand much less from their managers, funds aren’t able to charge nearly the same fees as for a fund under active management.

In late September of this year, a report by the Danish Financial Supervisory Authority (FSA) revealed that investors in mutual funds may not be getting their money’s worth. In scrutinizing 188 Danish ostensibly actively managed funds, 56 were discovered to be what the FSA called “closet passive,” meaning their portfolios were to some extent (in one case close to 80%) in fact passive funds masquerading as - and charging investors as if they were - actively managed.

The report also called into question the structure of fees charged by funds. Instead of allowing economies of scale to benefit investors, funds charge a fixed-scale fee no matter how much investors pour in, funneling these disproportionate fees to the banks. I’m no less puzzled than the FSA; assuming that investing 100,000 DKK doesn’t take ten times the work that investing 10,000 DKK does, why should I be charged ten times as much for placing that larger order?

Apropos of the relationship between funds and banks, it’s a confusing market. Mutual fund companies are on the surface independent entities, and the fact that many funds share parts of their names with banks shouldn’t interfere with the funds’ ultimate goal of increasing their investors’ monetary wealth. And yet, I’ve read that banks are in charge of appointing mutual fund boards of directors. If this is true, meaning that if in reality Danske Bank runs Danske Invest, Jyske Bank runs Jyske Invest etc., then which fund do you think Danske Bank would recommend when you arrive with a bag of investment-bound money? You wouldn’t be getting impartial financial advice, that’s for sure.

Then why not skip all the funny business and invest in super cheap foreign funds? Danes do have access to these, but returns are taxed differently than their Danish equivalents. Say I invest in an index fund from American company Vanguard and earn a 7% return over the following year. Under current regulations, I’m required to pay taxes on that 7% whether I choose to realize that return or not, and at a significantly higher rate than had the fund been domestic. In other words, I’ll be paying taxes on money I’ve never even seen. Now, I’m guessing I won’t have to pay taxes a second time if and when I do decide to realize my return, but the point is that this would be a pain to keep track of, and Danish tax authorities don’t exactly enjoy a reputation for leniency when it comes to claiming their money. Thus, this lowly Danish private investor has so far settled for the meager selection of Danish index funds, which, while still more expensive than their U.S. counterparts, won’t give me sleepless nights during tax season and are still much cheaper than actively managed funds.

Last week, a ruling in the courts of Germany, whose laws are similar to those here in Denmark, initiated a process that will hopefully ultimately simplify the taxation process for investors in foreign mutual funds, passive or active. According to the ruling, having different taxation regulations for domestic and foreign mutual funds is in violation of the free movement of capital. Furthermore, the European Commission has already initiated an investigation into the situation as it pertains to Danish law.

Since May of 2012 a series of no fewer than five Danish Ministers of Taxation have been dragging their feet regarding an analysis into precisely the issue of disparities between taxation of domestic and foreign mutual funds. Following many delays, the analysis was set for release in late autumn, until current Minister Benny Engelbrecht delayed it again. Here’s hoping the EU can give Danish lawgivers a much-needed kick in the ass, finally giving us cheap and easy access to foreign mutual fund companies such as Vanguard and iShares.