When a mutual fund starts acting like star athlete asking for a raise

Your Funds

July 24, 2005|By CHARLES JAFFE

PERIODICALLY, some superstar athlete will make a salary demand that comes down to "pay me or get rid of me."

Sometimes, mutual funds make the same demand of shareholders.

The question is what would you, as a fund investor, do if your fund made such a statement, and what options do you have.

It's more than a theoretical question for investors in the TIAA-CREF funds. Last week, the New York pension giant filed a proxy statement that would nearly quadruple the annual costs for its actively managed institutional mutual funds, some of which are sold to individual investors.

If the fee and structure changes are approved, TIAA- CREF then plans to fold its retail funds - ordinary issues like TIAA-CREF Growth Equity Fund (TIGEX) - into the institutional funds. That secondary move will require yet another proxy vote, one in which shareholders in the retail funds will be asked to pay more.

No one can accuse TIAA- CREF of cost gouging. The firm is consistently among the industry's low-cost leaders.

TIAA-CREF's 94-page proxy - a sure cure for insomnia - notes that the management has been losing money on the affected funds.

The proposal asks shareholders to OK a price increase that lets management make some money. For the TIAA-CREF Institutional Small-Cap Equity fund (TISEX), for example, that means bumping the expense ratio from 0.15 percent - a level that most industry watchers would expect to see only in an index fund - to 0.55 percent.

The retail class of the same fund will see a fee increase from 0.30 percent to the same 0.55.

The increase includes a 12b-1 fee - for the sales and marketing of the fund - of 0.25 percent.

That portion of the fee, which shareholders also must approve, will not go into place until April 2007 at the earliest.

By comparison, the average domestic equity fund has an expense ratio of about 1.4 percent, which means that the TIAA- CREF funds remains a cheap date.

But few investors want to volunteer for a price increase.

In the case of the 12b-1 fee, investors are being asked to pay more so that the firm can gather more assets; if the firm gets that additional money, it may then be able to hold the line on future cost increases.

It's easy to see why a management company wants this deal, but not a shareholder, as there's never been a study showing that increased costs have some benefit to investors.

Fund companies that come out and ask shareholders to pony up more money always use dire terms. The TIAA-CREF proxy notes that if the increase is not approved, the firm could stop taking money, or might liquidate the funds.

A TIAA-CREF spokesman confirmed that if fee increase does not get passed in the proxy vote, the board could liquidate the funds without having to hold any other poll of shareholders.

That leaves investors in a sticky place, like the general manager of the sports team whose star player has just demanded more money.

If you are happy with the funds and don't want to lose them, you approve the deal and adjust your return expectations accordingly. Since expense ratios come right off the top of the performance pile, if costs rise by about 0.4 percentage points, you can expect annualized returns to fall by that count.

That doesn't seem like much, but say a fund has a gross return - the amount it earns before expenses are deducted - of 8 percent. The small fee increase means that an extra 5 percent of the gross returns go to the investment company instead of the shareholder.

If you don't want to pay the additional costs - or if the reduced expectations might make you rethink holding the fund - you either make a change or vote against the increase and see how things play out.

Fund firms seldom lose proxy votes.

You've got a manager who doesn't want to run the fund at your price stuck with the job.

Their options tend to be liquidation, another proxy vote - at shareholder cost, of course - or quitting the fund, leaving investors stuck with a replacement manager who may only do the work at a higher cost anyway.

Ultimately, fund investors need to view every potential cost increase skeptically, because expenses are guaranteed, but good returns are not. Judge just how reasonable the increase is - and some price increases happen without a proxy vote, so review expense ratios periodically to see the trend - and decide if the fund is still attractive at the new price schedule.

Charles Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or at Box 70, Cohasset, Mass. 02025-0070.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.