It's time for the mutual-fund industry to deal with the problem of expenses

May 03, 1992|By Thomas Watterson | Thomas Watterson,Boston Globe

Riding one of the most remarkable success stories in investing history, the mutual-fund industry should be ready to deal with some of the more mundane issues it has overlooked.

One of those issues is expenses. While the industry has grown from about $100 billion in assets in 1980 to more than $1.4 trillion today, expenses and fees have continued to rise, in apparent defiance of the rules of economy of scale.

During the 1980s, for example, the average "fund expense ratio," the percentage of assets taken out of every fund each year to pay for things like salaries, equipment, advertising and mailing, rose from 1.08 percent to 1.27 percent, according to Don Phillips, publisher of Morningstar Mutual Funds. That increase came while assets in stock and bonds funds were swelling from $49 billion to $541 billion.

There are reasons for some of this increase, industry sources say. The averages include many newer funds, which tend to have higher expenses. They may also include marketing and sales expenses, and many fund companies are spending much more on research to find better stocks and on computers and phone equipment to handle the volume.

Good performance can easily overcome high expenses, Mr. Phillips notes. In 1980, the Oppenheimer fund had an expense ratio of 0.96 percent, while Fidelity's Magellan fund charged 1.4 percent. Yet over the decade, Magellan provided a compounded annual return of 21.3 percent, while Oppenheimer plodded along with a 5.5 percent annual return.

Still, Mr. Phillips is concerned that if expenses keep rising and are added to other fees and sales charges, people may be vulnerable to sales pitches for investment vehicles that aren't as good as mutual funds but play on rising costs.

For example, "wrap-fee accounts" pool money -- usually $10,000 or more per person -- and place it under the care of one investment manager, who's supposed to do a better job. But these accounts generally charge 3 percent of assets and don't provide superior management, Mr. Phillips says, because most investment companies have their best managers running the more-visible mutual funds.

Not everyone thinks expenses are that big an issue.

"It's a non-issue," says Nicholas Kaiser, president of Saturna Capital Corp., a money management firm in Bellingham, Wash.

Mr. Kaiser is a past president of the No-Load Mutual Fund Association and his firm manages three no-load funds. "If shareholders didn't like the expenses, they wouldn't buy the funds," he says.

There have been several studies on mutual-fund expenses, and they have reached conflicting conclusions, notes William E. Donoghue, publisher of Donoghue's Moneyletter in Ashland, Mass.

Last year, IBC/Donoghue Inc. did a study that indicated that -- up to a point -- higher expenses can mean better returns, because the fund managers can do better research.

The Securities and Exchange Commission has not tried to regulate the size of expenses, Mr. Donoghue notes. But it has taken several steps to require more-complete disclosure of all expenses, sales charges and other fees, and to make sure these costs are broken down so investors can see them.

As a result, Mr. Kaiser says, the issue of rising expenses "may be like crime statistics. Is there really more crime, or is more crime being reported?"

While many of the funds with the lowest expenses are no-load funds that don't have a sales charge, "expenses aren't a question of load vs. no-load," Mr. Phillips says. Some of the funds offered by no-load companies such as Janus, Scudder and Vanguard have low expenses, he notes; but so do funds sold by the American Funds Group and the FPA Group, two load companies.

The fund industry performed so well in the 1980s that growing expenses could be largely ignored, Mr. Phillips says.

But if fund returns are more in line with historical norms in the 1990s, it will be harder to justify these expenses, and fund companies that have kept them low, or found ways to cut them, will be rewarded with more shareholders.

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