Fund fees fall, but there is room for further reduction

Your Funds

Your Money

June 26, 2007|By Charles Jaffe | Charles Jaffe,Marketwatch

To paraphrase legendary broadcaster Arthur Godfrey, investors should be proud to own good mutual funds. The only thing is, they could be just as proud for half the money.

While fund fees are not being cut in half, the most recent data available says that fees are on the decline; in 2006, the industry now claims they were at the lowest level in more than 25 years.

The only question is whether you, as an investor, felt that cost savings.

Chances are you did, without even knowing it. And, until and unless fees actually are cut in half, you'll probably be the typical consumer and assume costs keep going up.

There's a distinct difference between costs coming down and costs being sufficiently low - while I believe the data, that doesn't mean I'm satisfied as a consumer - but one thing that's clear from the expense numbers is that investors are "getting it." They understand that low costs lead to better returns, and are investing that way.

The Investment Company Institute, the trade association and lobbying arm of the mutual fund industry, released its latest study on fees last week, measuring fees based on where the money is. Rather than looking at the average fund's fees - which stand at roughly 1.4 percent for a stock fund - the ICI study gave more weight to funds with more assets. So rather than look at a fund with $1 billion in assets and one with $10 million the same way, the ICI study looked at what the typical consumer is paying, based on where the cash is.

For 2006, the average investor paid 1.07 percent in fees and expenses (including loads) on a stock fund - down from 1.11 percent in 2005 - and the average in bond funds was 0.83 percent. While the industry can crow about how fees are off, on average, 0.5 percentage points since 1980, it's not because fund companies are suddenly magnanimous.

Instead, the cut in the average amount being paid by investors comes from several factors:

Growth in fund assets creates greater economies of scale and pushes funds past fee "breakpoints." With a strong market over the past few years, fund assets are on the rise; many funds cut expenses at predetermined levels as assets grow. Where a billion-dollar fund was once a rarity, today it's commonplace. That means the billion-dollar fee breakpoint is common, too.

Funds change their structure, or institute performance-related fees. Some funds pay management based on performance against an index, so that management gets paid better if it can deliver superior results. In other cases, directors alter the fund's structure, rejiggering breakpoints, or changing transfer agents and pocketing operational savings and so on. The Clipper fund (CFIMX), for example, cut expenses by 0.49 percentage points last year because the new managers charge a lot less than the guys they replaced, and the board passed the savings on to investors.

Domination by a few large, popular, low-cost fund families. With roughly a third of fund assets controlled by three companies - Fidelity, Vanguard and the American funds - there is little doubt that competition has played a factor in reducing costs.

For years, observers believed that the only thing that would drive assets to one company or another was raw performance. But a previous ICI study showed that consumers tend to look at costs before past returns.

What's remarkable about the decline in fees is that investors have been gravitating toward international funds in recent years, buoyed by the strong market performance overseas. International funds have higher costs.

"I would not have been surprised to see expenses go up last year, just because so much money was going into international funds," says Sean Collins, senior economist for the ICI, "but investors appear to be gravitating fairly consistently towards the lower-cost funds, and that is going to put pressure on the market, and will force costs to continue coming down in the future."

Clearly, there is room for further reductions, and no one should allow the fund world to crow too loudly about the gains it seems to have made here. The public has pushed for the change, and until the cuts become much larger, investors most likely will still believe they're paying too much.

jaffe@marketwatch.com

Charles Jaffe is senior columnist for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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