THE SEC WAVES AN AX AT MUTUAL-FUND FEES
For years, mutual-fund investors have been complaining to the Securities & Exchange Commission about big upfront charges when they buy funds, hidden expenses imposed on them while they own the fund, and surprise exit fees when they sell. Now, relief may be on the way. After its first comprehensive review of the 52-year-old laws governing mutual funds, the SEC is about to unveil a package of proposals that could lower the costs of investing in mutual funds.
The most critical part of the overhaul is to promote competition by deregulating the sales charges--called loads--set by fund sponsors on shares sold through brokers (table). Fund management companies such as Franklin, Putnam, and Templeton fix the load percentage, but most of the money goes to the brokerage firm that sells the funds to investors. The change, if approved by Congress, would allow investors to negotiate lower loads with their brokers.
MORE DICKERING. That could send tremors through the mutual-fund industry, where two-thirds of the assets are in load funds. Brokers that refuse to cut loads could see their business dry up. And fund management companies whose wares were pushed by brokers because of their fat commissions might find their sales evaporating, too. On the other hand, brokers willing to dicker could prosper as their sales soar. "Negotiated loads," says Jack White, president of Jack White & Co., a San Diego discount broker, "would allow no-load fund buyers to seriously consider buying load funds. That's not something they do right now."
One fund executive at a major brokerage house doubts there will be a mad rush by investors demanding discounts. "Clients can already buy no-load funds, but they choose to buy load funds through a broker," says Michael Scafati, a vice-president at A. G. Edwards & Sons Inc. "Many need the advice and help of a broker." Then again, discount brokers such as Waterhouse Securities Inc. and Charles Schwab & Co. might fight for those investors by offering load funds for the standard fee on a stock transaction. That could work out to as little as 1% on a $5,000 investment compared with as much as 8.5% now. "There are many top-performing load funds that people would want to buy on a discounted basis," says Barbara Heinrich, a senior vice-president at Schwab.
Although brokers may take the biggest hits from price competition, managers of load-fund companies are not happy, either. Jon Fossel, chairman of the $20 billion Mppenheimer Management Corp., says there's plenty of competition already. "You have no-loads and all kinds of loads," he says. He also questions how negotiated loads will help small investors. "Investors without clout will get hurt," says Fossel. "Deregulation could result in higher prices for some."
The SEC proposals to increase price competition accelerate a trend already under way. A decade ago, nearly all broker-sold funds carried a steep 8.5% load. But competition from no-loads and investor resistance have driven loads down to an average of 5%. Funds can charge lesser amounts for larger investments--usually above $10,000--but those fees must be published in the prospectus and no discounting is allowed.
GETTING TOUGH. But as loads have come down over the years, other fees have gone up--for which the SEC can partly blame itself. With the industry in a funk during the early 1980s, the SEC allowed fund sponsors to levy special charges on fund assets--known as "12(b)-1" fees--to pay for marketing expenses. Sponsors vowed that as their funds grew, the resulting economies of scale would allow them to reduce fees sharply.
That didn't happen. While the industry's assets soared sixfold over the last decade to $1.5 trillion, fund sponsors kept more for themselves: According to Morningstar Inc., expenses for equity funds soared 41%, to 1% of assets, adjusted for the size of the funds. While loads fell, many funds quietly recouped some of the money by levying 12(b)-1 and "back-end" fees charged to investors who sell before a specified period.
Now, the SEC is getting tougher with those fees, too. The commissioners are expected sometime this summer to approve a separate proposal by the National Association of Securities Dealers that would limit annual 12(b)-1 fees to 0.75% of fund assets. Now, there's no cap at all. What's more, the proposal would begin counting 12(b)-1 fees as part of the maximum sales charge allowed. That would ensure that most investors don't pay more than 8.5% when all 12(b)-1, front-end, and exit fees are combined.
To be sure, there's no guarantee that the SEC's proposals will sail through Congress. "The lobbying from the mutual-fund industry and brokerage communities will be strong," promises Reginald E. Barnes, managing director for Memphis brokers Morgan Keegan & Co. But with small investors choking on the fees they're being charged, there will be plenty of grass roots pressure on lawmakers to follow the SEC's lead.REINING IN THE COST OF OWNING MUTUAL FUNDS
SALES CHARGES Permit investors to negotiate with brokers over the up-front
sales charges, known as "loads"
DISTRIBUTION FEES Cap the 12(b)-1 fee, which is a marketing charge paid from
fund assets, at 0.75% annually
HYBRID FUNDS Create a closed-end fund that allows investors to redeem their
shares periodically at full net asset value
UNI-FEE FUNDS Allow funds to consolidate all of the various fees--management,
custodial, legal, etc.--under one unified charge
DATA: SEC, NASD, BW
Dean Foust in Washington, with Jeffrey M. Laderman in New York