Do Mutual Fund Fees Have to Be So High?

At a time when mutual funds are facing increased scrutiny from many directions, there is one longstanding criticism: They cost too much.

Before even considering this indictment, we can stipulate that the fund business is a bona fide success story with a well-designed product and hordes of satisfied customers.

All these positives notwithstanding, the argument persists that fund investors, as a group, pay more than they ought to in fees--sales fees, redemption fees, management fees, administrative fees, account fees, 12b-1 fees, etc.

As competition intensifies in the industry, with more than 4,500 funds currently on the market, most of those fees have remained stubbornly high.

Bigness, to the tune of better than $2 trillion under management, also has failed to deliver on the promise of economies of scale.

In his book “Bogle on Mutual Funds,” John Bogle, chairman of the Vanguard Group of Investment Cos., notes that expenses as a percentage of assets at the average stock mutual fund more than doubled from 0.7% in 1961 to 1.5% in 1992.

This increase occurred as stock-fund assets swelled to nearly 20 times their former size, from less than $25 billion to more than $460 billion.

“Given the clear financial impact of expenses on mutual fund performance, along with the exponential growth of industry assets, we might expect that fund expense ratios would have declined over the years,” Bogle says. “However, the reverse has proved true.”

“What we are witnessing,” he adds a couple of paragraphs later, “is not only the failure of managers to share economies of scale with fund shareholders but also their penchant to increase costs to fund investors at an even faster rate than fund asset growth.”

Consider the specific case of 12b-1 fees, which are charges deducted from the assets of a fund annually to “pay for distribution costs such as advertising or for commissions paid to brokers,” in the definition of the Investment Company Institute.

“Without question, the worst abuses imposed on mutual fund shareholders during the last decade have been 12b-1 charges,” declares Norman Fosback, editor of a group of financial advisory letters, in his book “Mutual Fund Buyer’s Guide 1994.”

“Nearly half of all funds now impose these egregious charges. The total cost to all fund shareholders now exceeds $2 billion a year.”

Whether such fees are “fair” is debatable. More to the point economically, fund advisers are able to collect their fees because investors don’t object to paying them.

Fund groups’ own surveys repeatedly show investors are far more concerned with investment performance than with how much they are charged in fees.

Because most expenses are deducted straight from the funds themselves, the people who pay them never have to sit down and write a check or count out dollars and cents from their pockets. It’s a sort of painless extraction.

Secondly, will investors’ attitudes toward fees and expenses remain as benign when the market climate turns less favorable, making it tougher for funds to show generous performance results?