Funds scandal might do good

Investors' attention drawn to firms' fees

`Millions ... paying too much'

Pressure to cut charges may lead to better returns

December 26, 2003|By Ken Moritsugu | Ken Moritsugu,KNIGHT RIDDER/TRIBUNE

WASHINGTON - The mutual fund scandals may have a silver lining: They could spur reductions in mutual fund expenses, increasing returns to investors.

One fund company, Alliance Capital, agreed to reduce its fees in a recent settlement with prosecutors. Separately, the Securities and Exchange Commission is discussing whether to force funds to disclose certain expenses more clearly to investors.

Ultimately, the scandal's greatest impact on expenses may be a growing public awareness of their cost. Investors may vote with their feet and flee high-cost funds. That, more than prosecutions or new regulations, is what would really drive down fees, industry watchers say.

"It's going to give low-cost shops a real opportunity to advertise their brand, and if that proves successful, other fund companies will lower their fees," predicted Lucas Garland, a Denver-based research analyst at Lipper Inc., which tracks the mutual fund industry.

The fees average 1.48 percent on stock funds and 0.98 percent on bond funds, according to Lipper, and they reduce a fund's annual return accordingly. While the cost in one year may be modest, over time those fees can take a substantial bite out of an investor's gains.

"People that do watch fees wake up richer 20 years later," said Max Rottersman, a New York-based mutual fund analyst.

Many mutual fund investors focus on past performance in choosing their funds, something many experts say is a mistake. Investors are hoping that the past is a gauge to future performance, which is unpredictable. More emphasis should be placed on fees, which are knowable, the experts say.

"The primary thing people look at is past performance, as misguided as that may be," said Edward O'Neal, an assistant professor of finance at Wake Forest University in Winston-Salem, N.C. "Whether we'll be able to change the collective rationale on that, that's an open question. If anything good comes out of the scandals, it's that people will begin to pay more attention to fees."

Industry data suggest that some investors were moving toward lower-cost funds even before the mutual fund scandals erupted in September.

But others continue to pay above-average fees, said Mercer Bullard, a University of Mississippi law professor and founder of Fund Democracy, an advocacy group.

"There are still tens of millions of people out there paying too much," said Bullard, who is a former assistant chief counsel in the mutual funds division of the SEC.

Investors at Alliance Capital, which runs Alliance and AllianceBernstein funds, pay above-average fees. The expenses on its stock funds average 2.12 percent, according to Lipper.

Alliance also has been implicated in the market-timing scandal.

To settle those charges, the New York-based firm has agreed to reduce its management fees by 20 percent for the next five years, which will save investors an estimated $350 million.

The SEC fined the firm, but commission officials have opposed seeking fee reductions in settling the market-timing and late-trading cases.

"I do not think that the government should serve as a fee setter in enforcement actions or otherwise," SEC Chairman William H. Donaldson said at a recent commission meeting.

Alliance's management fee is close to the industry average, but its total fees, which include marketing and administrative expenses, are higher.

Other firms with high fees may come under pressure to lower them, O'Neal said, because the boards of directors of their funds are charged with looking out for the interest of investors.

"To the extent that scrutiny is being brought to bear on fees, that may cause other mutual fund companies to take a hard look at their fees," he said.

The five SEC commissioners proposed rules that would require mutual funds to provide better disclosure of sales charge discounts available to investors who put at least $25,000 into a company's funds.

An examination late in 2002 revealed that many investors weren't getting discounts for which they were eligible.

The commission also decided to seek public comment on ways to improve disclosure to investors of the trading costs incurred by mutual funds when they buy and sell stocks and bonds.

"Investors should be fully informed about the fees they are being charged," Donaldson said.

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