Mutual Fund Fee Disclosure Inadequate
Ever wonder what it costs to have your investments professionally managed in a mutual fund? Looking at the account statement from your fund company probably won’t provide a clue.
Mutual funds typically disclose their fees just once -- in the prospectus that’s provided to investors before they buy shares in the fund. The expenses -- sales charges, market costs and management fees -- often are expressed as a percentage of the amount invested, or assets.
After that, fees usually aren’t broken out in the quarterly account statements sent to investors. The charges are simply deducted from the fund’s total returns, making the cost of management all but invisible.
Like other aspects of the mutual fund industry that have drawn the attention of Congress this year, fee disclosure has become a hot topic on Capitol Hill.
“The disclosure is not adequate, in my judgment, to see what this investment yielded and what the real costs of that investment were,” said Rep. Richard H. Baker (R-La.), chairman of the House capital markets subcommittee.
Moreover, fee disclosures omit internal transaction costs -- such as the trading fees and commissions paid by the fund when it turns over its investments -- and these are sometimes the most significant costs borne by investors, said Mercer Bullard, president of Fund Democracy Inc., a mutual fund shareholder rights group based in Mississippi.
“Most people assume that these internal trading fees and commissions are included in the expense ratio for a mutual fund, but they’re not,” Bullard noted. “If you want to find them, you have to request the ‘statement of initial information’ and dig it out. It’s literally buried in there.”
Fees to Brokers
Then, too, 12b-1 fees -- marketing charges paid in increments -- and upfront sales charges don’t necessarily reflect the total commission paid to the broker, Bullard said. That’s important because the commission gives investors a clear look at how much financial incentive the broker has to peddle a particular investment.
Fund companies often pay brokers several times the 12b-1 fee rate noted in the prospectus as an incentive to sell the fund, he said. That’s not illegal or even improper, but it’s something investors should know, Baker added.
“It’s fine for the buyer and seller to engage in any transaction they wish, as long as they disclose it,” Baker said. “These revenue-sharing arrangements are an expense to you as an investor, but nowhere is it disclosed.”
Investment experts and dozens of studies have found that expenses have a significant effect on investor returns.
A recent study by Standard & Poor’s Corp., for instance, looked at the average performance of funds in nine investment categories -- from large-cap growth to small-cap value -- and found that funds with lower fees performed better than those with higher fees in every investment category but one.
Moreover, the better performance was consistent over time. Only mid-cap “blend” funds -- a mix of value and growth -- bucked the trend, with high-cost funds performing better than lower-cost funds on average.
In a 10-year period, funds with lower-than-average fees outperformed high-fee funds by 1.5 percentage points to more than 5 percentage points a year. Over time, that can mean a difference of tens of thousands of dollars in an investor’s returns.
In addition, the way fees are disclosed -- as a percentage applied against a hypothetical investment balance -- may obscure the full effect of fund charges. It’s difficult for investors to translate those figures into what they are actually paying, said Phil Edwards, managing director of Standard & Poor’s funds research.
“Investors need to pay closer attention to expenses, especially in a market environment where returns are expected to be in the single digits,” Edwards said. “It is in this type of setting that expenses can take a larger proportion of a fund’s return.”
The Securities and Exchange Commission, the General Accounting Office, several members of Congress and many consumer advocates agree that investors need better information on mutual fund fees. But there’s no consensus on how to accomplish that.
Baker wants fund companies to tell their customers in their quarterly statements exactly how much they paid in fees. However, the fund industry maintains that breaking down the costs on an investor-by- investor basis would be so expensive that it would further drive up costs.
Calculating Costs
The SEC, meanwhile, proposed that fund companies simply add a fee disclosure to their annual reports. This would largely mirror the fee disclosures now provided in fund prospectuses, expressing fees as a percentage of assets along with a hypothetical example showing the effect on a $10,000 investment.
Bullard of Fund Democracy believes there’s a middle ground: Disclose fees -- including a fund’s internal costs -- as a percentage of assets. Then provide an estimate of the dollar cost to each investor by multiplying that percentage by the investor’s average balance over the course of the year. It wouldn’t be exact, but it would be close enough and easy to understand.
“There’s no doubt that calculating the cost to the penny could be very expensive,” Bullard said. “But there are a lot of ways that you could do this. We don’t have to just focus on the most expensive option.”
No matter the form, improved fee disclosures probably are months away. In the meantime, investors must rely on their own resources to ferret out the information.
Savvy investors should read information from mutual funds and ask brokers about their commissions, Baker advised.
“Fees do matter,” he said. “Low fees translate to good management. Expenses are a good way of assessing the efficiency of the entire operation.”
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The effect of fees
Mutual fund fees can take a bite out of returns over time. HereOs how different fee levels affected the return on a $100,000 investment in funds with different expense ratios over various time periods. The examples assume average annual returns of 9% before fees.
Expense value of $100,000 investment after:
*--* Fund type ratio* 10 years 20 years 30 years Low-cost S&P; 500 index 0.2% $240,317 $577,523 $1,387,886 Avg. S&P; 500 index 0.7% $228,450 $521,897 $1,192,276 Avg. U.S. growth fund 1.2% $218,681 $478,213 $1,045,762 High-cost U.S. growth fund 2.0% $200,966 $403,874 $811,650
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*Management fees and other charges, expressed as a percentage of assets
Sources: Morningstar Inc.; Times research
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Times staff writer Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com/perfin.
