Sting of scandal followed by lower fees for many mutual fund investors

PERSONAL FINANCE

Your Money

September 19, 2004|By EILEEN AMBROSE

IT'S ABOUT time that small investors who stuck with mutual funds through a year of scandal got some good news.

Thanks to last year's stock market gains, fund settlements negotiated by New York Attorney General Eliot Spitzer and marketplace competition, fees at some mutual funds are coming down.

A survey by mutual fund tracker Lipper Inc. found that more than four times as many stock and bond funds lowered fees during the 12 months that ended July 31 as raised them. For the period, 528 funds cut management fees and 124 raised them. The year before, 240 funds cut fees and 304 increased them.

More recently, Fidelity Investments slashed fees on five of its index funds, dropping their annual expense ratio to 0.10 percent of invested assets. Its Spartan 500 Index Fund fee, for example, had been at 0.19 percent. Under the new fee, an investor with $10,000 would pay $10 each year, rather than $19.

The new fee structure undercuts the leader of low-priced index funds, the Vanguard Group, which Fidelity points out in a new advertising campaign.

Not to be outdone, online financial services company E-Trade, which had already trimmed fees on its index funds a few months earlier, cut fees again on two funds. The expense ratio on its S&P 500 index fund, for instance, dropped from 0.10 percent to 0.09 percent.

"If we are in a fee war, it's long overdue," said Barbara Roper, director of investment protection for the Consumer Federation of America.

The consumer advocacy group released a survey last year that figured shareholders pay more than $300 million in excess fees each year for money market and index funds, two basic fund types.

Some of the fee cuts are simply the result of a run-up in stock prices last year that lifted fund assets, said Edward O'Neal, a finance professor at Wake Forest University. Some funds automatically reduce their fees as assets rise, he said.

Other motives are at work, too.

"The industry doesn't do this out of the goodness of their heart. They do it because the market is driving them there or someone has a gun to their head," said Robert Mewshaw, chief investment officer at Van Sant & Mewshaw in Lutherville.

Holding the gun now is Spitzer, who led the investigation into abusive trading practices permitted by some mutual fund companies.

While settling cases with fund companies such as Janus, Strong and Invesco, the New York attorney general has made it known that he wanted concessions on fees that he says are far too high. Small investors pay a lot more in fees than large institutional investors for the same services, Spitzer maintains.

So far, Spitzer has negotiated fee reductions worth $920 million during the next five years.

Tom Roseen, a senior research analyst with Lipper, said fee cuts at those funds also prompted some companies untarnished by scandal to lower their fees, too. "To stay competitive, they had to drop their fees," he said.

Unrelated to the scandal is Fidelity's fee cuts on the five index funds. Even before these recent reductions, Fidelity had been offering the funds at below the cost it took to manage and administer them, the company said.

Fidelity estimates this latest round of cuts will cost the fund company up to $40 million a year in lost revenue.

"We see this as an opportunity for investors to give Fidelity a try. They may be thinking of a low-cost index fund and see some of our actively managed funds," said spokesman John Brockelman.

In that way, index funds are becoming a loss leader, like milk, where the product is sold below cost in hopes that customers load up on other items.

Some experts say Fidelity has its sights on drawing business away from the dominant low-cost index fund provider.

"Fidelity is really trying to attack the bastion of Vanguard," said Lipper's Roseen.

Vanguard's 500 index fund, the largest index fund in the country, charges a 0.18 percent annual fee for small investors, and an even lower fee for those with larger, older accounts.

Vanguard said it already offers its funds at cost. The fund company also points out that Fidelity's reduction is merely a waiver, which means fees can go up at any time.

However, Fidelity's Brockelman said, "It is for the long term."

No matter what is motivating fund companies to lower fees, the bottom line is that it's good for investors. Fees erode investment returns, yet too often are overlooked by investors, experts said.

"Fees are one thing when investing in mutual funds that you can control," said Wake Forest's O'Neal.

"Performance is impossible to predict, but by choosing low-cost funds you are at least stacking the deck in your favor to some extent," he said.

To suggest a topic, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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