Expense Ratios Becoming a Bigger Issue for Investors

Some of Munder NetNet Fund’s investors are paying a higher price to lose money than shareholders of any other U.S. mutual fund.

The Internet stock fund, managed by a unit of banking firm Comerica Inc., plunged 36% in 2002, worse than 90% of all funds. Investors who didn’t pay a sales charge when they bought Munder NetNet shares paid fees last year that amounted to 3.35% of what was left of their investment, according to Bloomberg data.

Those management fees are taken directly from the portfolio during the course of the year.

As mutual fund losses mount, the fund industry’s costs are rising as a percentage of assets under management.

Munder NetNet, with the highest expense ratio among all U.S. stock funds with at least $250 million in assets, is the most extreme example. Munder officials declined to comment on their expenses.

For the fund industry overall, “There’s been a large depreciation of assets, and there are certain fixed costs,” said Burton Greenwald, a fund consultant in Philadelphia.

Assets in U.S. stock funds were $2.8 trillion as of the end of November, down from $4 trillion at the end of 1999, according to Morningstar Inc.

The average stock fund expense ratio, which measures costs as a percentage of fund assets, has risen to 1.5% from 1.1% in 1999, Morningstar said.

For fund investors, expense ratios weren’t much of an issue during the 1990s bull market. With average annual fund returns in the double digits in the late 1990s, whether a fund charged expenses of 1% or 2.5% made little difference to most investors.

But many market pros believe that, at best, annual stock market returns over the next few years will be in the single digits.

If that’s the case, fund expenses could become a much bigger issue, because funds with higher expenses could eat up a substantial chunk of their investors’ returns.

“Fees are a huge predictor of a fund’s future performance,” said Russel Kinnel, Chicago-based Morningstar’s director of fund analysis. “If you choose a high-cost fund, you’re putting a huge handicap in your way and you’re not getting anything for it.”

When a fund’s assets shrink, managers usually can’t cut expenses as quickly and fixed overhead costs such as office space are spread over a smaller base.

Hard-to-cut expenses include printing and postage for semiannual reports to investors, accounting and legal bills and answering customers’ phone calls.

Easier-to-cut costs include staff expenses -- by laying off workers or cutting managers’ pay. Munder, for example, has fired two of the NetNet fund’s co-managers.

Investors in the Invesco Growth Fund, which had an expense ratio of about 3% last year, got a payback from the manager: Under an agreement to cap the expense ratio at 2.75%, Invesco repaid the fund 0.28% of assets, said Suzanne Smith, spokeswoman at the Denver-based firm.

The agreement is valid until July 31, 2004, according to the fund’s prospectus.