Fund Fees: Less Bang for the Buck
Mutual funds have blossomed into a mainstream investment vehicle over the past 20 years, with nearly one-half of U.S. households investing in them, compared with only 6% of households buying into funds in 1980. Additionally, assets under management in the U.S. mutual fund industry skyrocketed to a whopping $6.8 trillion by the end of 1999, dwarfing the modest $134.8 billion in assets 20 years ago. As fund assets have increased, investors might expect that economies of scale would result in mutual fund fees decreasing over this period. Wrong! Unfortunately for shareholders and prospective investors alike, an SEC report released in January revealed fund fees have actually risen over the past twenty years, despite the industry's growth.
The report, submitted by the Division of Investment Management, found that fund expense ratios—a fund's total expenses, including 12b-1 fees, divided by its average net assets—have increased over the past two decades. According to the study of both stock and bond offerings, the average expense ratio of an open-end mutual fund increased to 1.36% in 1999, from 1.14% in 1979. For the purpose of the study, 1979 was chosen as the benchmark year because it was when rule 12b-1 distribution fees were first permitted. On a weight-adjusted basis—a more accurate figure since it gives a proportionately higher weighting to fund companies with larger asset bases—expense ratios jumped to 0.94% in 1999, up from 0.73% in 1979. It should be noted, however, that fund fees have declined in three of the past four years through 1999.
So, what has caused expenses to rise significantly over the past twenty years? The study attributes the increase primarily to many load-bearing fund families having decreased or replaced their front-end loads with ongoing Rule 12b-1 fees. Unlike 12b-1 fees, which are marketing and distribution fees paid by shareholders, load charges are not factored into a fund's expense ratio. Over the long run, these fund companies will have shifted the burden of paying such fees to all shareholders, given that 12b-1 fees are paid to the fund annually, whereas front-end charges are incurred only during the purchase of new or additional fund shares. Although the report was not intended to help determine an appropriate level of fund expenses, its authors recommended that fund families provide more-detailed fee information to shareholders.
The SEC already requires fund families to print easy-to-read fee statements in their prospectuses, but the Division of Investment Management urged the Securities and Exchange Commission to go one step further, calling for additional disclosure of fee information provided in its semi-annual and annual shareholder reports. Under one such proposal, fund firms would have to add a new table to their fund reports that discloses actual returns and fees in a standardized dollar amount (e.g., $10,000) over a set period of time. Additional simplified fee information in fund literature would enhance an investor's ability to make a more-informed decision, but, unfortunately, fund expenses would undoubtedly rise if the SEC does indeed approve any of the proposed rules, as fund families pass on the added costs to their shareholders.
Although it remains to be seen what the SEC will do, fund investors should not ignore the importance of a fund's fees. You have to do your homework to see if you are getting your money's worth.
Charles Noh
Editor of Industry News |
