BUSINESSWEEK ONLINE : JANUARY 29, 2001 ISSUE
SPECIAL REPORT Commentary: No Excuse for High Fund Fees The fund industry giveth, and it taketh away. But lately, there's more taking. A Securities & Exchange Commission report this month figures the expense ratio of the average mutual fund soared nearly 28% between 1979 and 1999, when it reached 0.94% of assets--despite a huge, 85-fold increase to $6.8 trillion in the money the funds manage. So much for economies of scale. Unfortunately, the remedies the SEC is proposing to give fund shareholders a fairer deal fall far short of what's needed. Essentially, the regulators want to rely on investors and fund directors to put pressure on the funds. One SEC measure would require funds to disclose how much a theoretical $10,000 investment would cost in fees. But what investors need to see in their quarterly statements is exactly how much they're paying out in fees on their actual investments. The General Accounting Office recommended this idea to the SEC last June. But, fearful of a backlash from angry fund holders, the industry campaigned loudly against it. The lobbyists had reason: Nothing hits home with investors like seeing money taken out of their accounts. Another SEC ploy would try to bolster the watchdog role of a fund's independent directors. The SEC argues that independent directors should be a majority of a fund's board, instead of 40%, as the law now requires. Superficially, the idea looks good. After all, directors must approve any changes in fees. Trouble is, many ''independent'' directors are effectively closet employees of fund-management companies, serving on several boards at the same fund family. Some earn $200,000 or more for rubber-stamping managers' fee requests. Anyway, most fund boards already have a majority of these independents, who have done very little to lower fees. Just consider the adoption of 12(b)-1 distribution fees throughout the industry in 1980. Congress approved the fees, which charge shareholders for the funds' own marketing and advertising costs. The industry argued that by increasing their marketing expenses, funds could attract more investors and pass on cost savings through economies of scale. They were half right: The assets arrived, but the cost savings haven't ended up in shareholders' pockets. That so much is spent on marketing shows that mutual funds have become commodities. With a commodity, the majority of sales go to the low-cost provider, which is why penny-pinching Vanguard Group is attracting so many assets. Other companies have to market hard to differentiate themselves and justify charging more. Witness the recent spate of formerly no-load fund companies--Scudder, Strong, Founders, Gabelli--now offering load versions of their products because they need salesmen to move their product in a saturated marketplace. PAYMENT IN SHARES. The best way to knock fees down is to align the interests of directors with those of shareholders. How? By forcing them to eat their own cooking: Directors should be paid with shares of their funds, not in cash. Also, the number of boards they serve on should be limited. Although there's a law against compensating with fund shares, an exemption should be made in this case. Barring that, independent directors should be required to own fund shares before they take the job. More disclosure of how fund managers are compensated wouldn't hurt, either. At Vanguard and some other groups, fees paid to outside money managers are based on how well they do relative to a benchmark such as the Standard & Poor's 500-stock index. But funds don't have to disclose whether they vary the fees according to performance or simply pay a flat rate, regardless of how poorly a manager does. If investors are paying more for a money manager, they should get a discount when the manager falls down on the job. In raging bull markets, fund fees are easily overlooked, though they take a large bite over time. A 1% increase in annual expenses, the SEC notes, can reduce an investor's account balance by 18% after 20 years. In flat or falling markets, like the current one, high fees will stick out like sore thumbs--and maybe prompt regulators to take real curative action. By Lewis Braham Braham covers personal finance from New York. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The Best Mutual Funds TABLE: The A List TABLE: The Best Performers in Their Categories TABLE: The Largest Funds TABLE: The Fund Categories Caution: Your Fund May Be Top-Heavy TABLE: Diversified Funds Lose on Big Bets Funds That Can Dodge Tax Bullets TABLE: Weighing Funds' Tax Baggage Commentary: No Excuse for High Fund Fees SCOREBOARD: Equity Funds: Mutual Fund Scoreboard (.pdf) Interactive Mutual Fund Scoreboard INTERACT E-Mail to Business Week Online

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