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Of course not. Yet Americans each year are spending billions to help mutual-fund companies pay for advertising and other marketing expenses. These range from logo-adorned coffee mugs, mouse pads, baseball caps, and other dreck, to lunches for investment advisers and others who can help direct money to a fund family. Just this week, yours truly declined a fund marketer's invitation to a Major League Baseball game. All this adds up -- big-time. The tab last year came to more than $6 billion, Vanguard Group Senior Chairman John Bogle writes in his new book, Common Sense on Mutual Funds (John Wiley & Sons, 468 pages, $24.95). And that was just the amount collected in so-called 12b-1 fees. The book also points out that investors pay millions more to see their funds become part of the large "supermarkets" run by the likes of Charles Schwab and Fidelity Investments. DUBIOUS THEORY. Can this be legal? Strangely, the answer is yes. Back in 1980 -- a time when the fund industry was hurting -- the Securities & Exchange Commission agreed to let fund sponsors levy these fees on the dubious theory that if fund holders helped pay for ads, more money would flow into the funds and, as economies of scale took hold, investors' total costs would fall. The fund providers -- see accompanying table "Fund Fee Hall of Shame" for a list of some of the big firms charging maximum marketing fees -- claimed that in the end, shareholders would benefit.
To see how 12b-1 fees had affected total shareholder costs, Siggelkow performed a statistical analysis of thousands of funds over the period 1992 to 1996. He looked at the data many different ways, controlling for such variables as different kinds of "loads" or sales charges, the age of each fund, and its level of customer service. None of those mattered. SAME RESULT. "The costs go up, and they stay up," Siggelkow found. "Any way you shake it, any way you slice and dice it -- using new funds, using old funds, using funds that switch [from no 12b-1 fee to charging a 12b-1 fee] -- that result always comes out to an almost a one-to-one relationship: You charge 20 basis points or 30 basis points in 12b-1 fees and, lo and behold, controlling for anything else, your expense ratio is 20 to 30 basis points higher." (A basis point is one one-hundredth of a percentage point.) In our free market, it's no surprise that the fund sponsors should do everything they can to increase their profits. But the way funds are organized under federal securities laws -- and the way the 12b-1 rule is written -- the men and women who sit on the funds' boards of directors are obliged to look out for the fund holders' interests first. In other words, they're supposed to ask: Is this 12b-1 fee helping investors in the fund? Siggelkow's research, which also found that the funds' use of so-called "soft dollar" rebates on stock-brokerage commissions is not aiding fund investors, hasn't yet been published and so remains untested by potential critics from Wall Street. He is set, however, to present his paper to some leading Wall Streeters at a conference Wharton is holding on May 7. I'm betting that once his findings are widely known, it will be harder for fund directors to keep a straight face when claiming that 12b-1 fees are benefiting the investors to whom they owe a fiduciary duty. In the meantime, you can help yourself by resolving never to buy a fund that levies a 12b-1 fee, something you should have little trouble doing if you just keep your eyes open. Although 6,722 of the 10,614 funds in Morningstar's database charge 12b-1 fees -- and more than a third of them take the 1% maximum -- that still leaves 3,892 that don't. Look to those first. Barker covers personal finance in his weekly column, The Barker Portfolio, for Business Week from Melbourne Beach, Fla. And he appears every Friday on Business Week Online
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