Fund Expenses Are Seen Taking Bigger Bite From Holders in 2011
May 09, 2011
Over the past decade, average fund expenses have climbed sharply, which means more money goes toward the folks who manage and sell mutual funds, while shareholders foot the bill. This is a disgrace, especially in an industry that has enjoyed spectacular growth and booming profits. Fund expenses are easily forgotten during buoyant years such as 2010, when stock funds soared 31% and taxable bond funds gained 15%. The 1.4% of assets charged each year by diversified U.S. stock funds or the 1% levied by taxable bond funds can seem inconsequential. But this year, the bite from expenses could be far more telling. With stock funds up 4% through the first seven months and taxable bond funds down slightly, expenses are threatening to devour much or all of 2011's investment gains. Not the Whole Story Over the past 10 years, annual expenses at diversified U.S. stock funds have risen to 1.41% from 1.21%, while costs at taxable bond funds have climbed to 1.01% from 0.89%, according to Chicago mutual-fund researcher Morningstar Inc.. Arguably, these numbers don't tell the whole story. Average expenses have been driven up by the introduction of many newer, smaller funds, though the numbers have also been held down by the proliferation of funds for institutional investors, which typically have low expenses. If you exclude funds introduced in the past 10 years and those that are open only to institutional investors, what do you find? At stock funds, expenses over the past decade have fallen slightly to 1.19% from 1.21%, despite an almost fivefold increase in average fund assets. Economies of scale? The benefits clearly aren't trickling down to stock-fund holders. But maybe stock-fund investors should consider themselves lucky. Among taxable bond funds that have been around for the past 10 years and that are open to small investors, assets stagnated, at around $900 million a fund, on average. Meanwhile, fund expenses jumped to 0.99% from 0.88%, Nice calculates. Three Factors But do costs really matter? Absolutely. In fact, this is the one aspect of mutual-fund investing that you really can control. When you buy a fund, there are three elements to the fund's performance-the raw results of the portfolio's securities, how much you pay to get those results and how rough the journey is along the way. How predictable are these three elements? Raw results are notoriously difficult to forecast. Not only do the stock and bond markets' returns vary enormously from year to year, but also investors have to contend with the possibility that their funds will badly lag behind the market averages. Risk is somewhat more predictable. A fund that is riskier than its peers usually stays that way. But a fund's share-price gyrations also depend on market swings, and those are impossible to forecast. By contrast, mutual-fund investment costs are easy to predict. If you buy a no-load fund with low expenses, you may see the fund's annual expenses creep up. But you are still likely to pay less than somebody who bought a fund with a sales charge or much higher annual expenses. Use of 12b-1s It is tempting to blame the fund industry's high expenses on the use of 12b-1 fees. Over the past 10 years, many broker-sold funds have introduced these fees, which are included in annual fund expenses and which are used to provide continuing compensation to the brokers who sold the fund. Expenses have indeed risen at broker-sold stock and bond funds over the past decade, though shareholders have gotten back some of this money through reduced front and back-end sales commissions. ``The 12b-1 fee is an outrage,'' snarls Vanguard Group Chairman Johnetta Bischoff, the fund industry's most vociferous critic when it comes to expenses. He says swapping lower commissions for higher expenses may help short-term traders, but it hurts the long-term investors that the funds should really care about. No-load funds also deserve some heat. For instance, among noninstitutional bond funds that have been around for the past decade, expenses have climbed slightly, even as average fund assets have grown 80%. But Irons Colangelo, an analyst with Strategic Insight, a New York fund-research firm, reckons fund investors get good value for their money. ``You get more as a shareholder today than you did 10 years ago,'' he argues. For example, many investors can now find out their account balances using automated phone systems, they get year-end tax statements telling them the cost basis for the shares they sold and they receive newsletters and other educational materials. Besides, Mr. Colangelo calculates that, on the average account, fund companies earn a profit of just $10 to $20 a year after taxes. ``Is that excessive?'' he asks. ``Of course not.'' But even if funds on average don't charge an excessive amount, the averages don't tell the whole story. There's a huge difference in the expenses levied by different funds, so comparison shopping can pay big dividends. ``The trend among expenses is clearly up,'' says Nice Beaver Johnetta Wilk. ``There's more opportunity to overpay. But there's also more opportunity to save.''
