Firms Slash Fees as Investors Flock to Low-Cost Portfolios

Times Staff Writer

Mutual fund companies have long boasted about the performance of their offerings. But, in today’s volatile market, they’re touting something else to win investors: low fees.

That’s a message Wayne Redfearn can get behind. The Newport Beach business owner has been investing aggressively in an effort to finance his young children’s college education and his own retirement. The more you have invested, the more fees matter, he said.

“If you look at the numbers, even a small reduction in fees means many thousands of dollars to me” as a long-term investor,” said the 58-year-old Redfearn.

He chose his mutual fund company, American Funds, in part because its recurring fees were low, despite upfront sales charges. Recent 10% fee cuts by the Los Angeles-based firm have given him more to cheer about. For a portfolio of U.S. stocks, he now pays an annual management fee of 0.56% of his assets in the fund, compared with an average charge of 1.4% for such funds, according to researcher Morningstar Inc.


Other fund companies, including Vanguard Group, Fidelity Investments and T. Rowe Price Group, are also slashing fees, helping to bring mutual fund expense charges down 4.2% in 2005, according to the Investment Company Institute, the industry’s biggest trade group.

Much of the credit goes to New York Atty. Gen. Eliot Spitzer and his crackdown on improper mutual fund trading practices that hurt returns and raised costs for average investors.

As a result of settlements made since Spitzer’s probe began in 2003, 11 fund companies have reduced fees and saved investors nearly $1 billion, said Russ Kinnel, Morningstar’s director of fund research.

The Securities and Exchange Commission also helped the low-fee cause by requiring mutual fund boards to better explain fees and charges in prospectuses, Kinnel said, making it harder to hide the costs in the fine print.


Finally, the lackluster U.S. market also contributed, because fees eat up an increasingly noticeable portion of investment returns in a market that’s making little progress -- or losing ground, as almost all major categories of stock funds did in the second quarter.

“When you think about one fund charging 1.5% and another charging 0.5% for the same service, particularly in this low-return environment, you realize that’s a huge percentage of your return,” Kinnel added.

That point has not been lost on investors, who are pouring money into the funds with the lowest fees and turning cost cutting into a competitive edge.

“It is the market at work,” said Mike McNamee, a spokesman for the Investment Company Institute. “Competition is on fees, and investors are flocking to the lowest-cost funds.”

Mutual fund fees may seem small, but on large investments held for long stretches, they add up.

The difference of just one tenth of a percentage point -- roughly 10 cents for every $100 invested -- saves an investor with $100,000 about $100 a year. But if that individual leaves his money invested over 30 years and earns an average of 10% on his money, the savings mushrooms to $58,152.

“The difference compounds over time and magnifies,” Kinnel said.

There are three types of fees associated with mutual funds:


* Loads, which are sales charges levied by some, but not all, funds. Loads assessed at the time of purchase are called front-end loads, and those charged when selling are called back-end loads.

* Annual management fees, which cover the cost of managing the fund and choosing investments. These are charged by all funds.

* 12(b)1 fees, which are levied by some funds to cover sales and marketing costs.

Funds report fees taken annually to cover management, operating and marketing costs as an “expense ratio” expressed as a percentage of fund assets.

Fund companies have long disclosed expense ratios in their printed prospectuses, but the Internet has made tracking these costs much easier. Most fund companies report their fees online. In addition, and websites operated by other groups allow investors to comparison shop.

“Fees have always been disclosed in prospectuses, but with the publication of fees available on the Web, you can sort by expense ratios and total returns,” said John Sweeney, senior vice president of mutual fund product management at Fidelity Investments in Boston.

“People who are cognizant of fees as a component of total return can now sort using that criteria,” Sweeney added.

The relative ease of checking fund costs on the Internet may be another reason more investors are switching to lower-cost funds. Roughly 70% of new money pouring into mutual funds is earmarked for those that charge fees below the average for their peer group, according to the Investment Company Institute.


That’s a significant change in attitude, said Francis M. Kinniry, who runs the investment counseling and research operation at Vanguard.

Back in the 1990s, when annual returns of 18% were typical, many investors saw fees as barely significant. “Instead of getting 18% on stocks, you were getting 16.5% after fees and no one was complaining,” Kinniry said.

Although most companies are slashing fees, there are differences in degree and approach.

Vanguard and Fidelity, two of the biggest fund companies, are among those giving discounts for investors who are willing to maintain relatively high balances.

Vanguard, for example, announced last year that it would automatically shift investors with $100,000 in assets into so-called Admiral shares, which are available in about half of the company’s 135 funds.

The only difference between Admiral shares and others is that Admiral shares are cheaper. The Vanguard 500 Index fund -- the company’s largest, with $105 billion in assets -- charges 0.18% to the average investor, but just 0.09% to those who qualify for the Admiral class.

Late last month, Vanguard made Admiral shares available in its emerging markets fund, which normally charges 0.41% annually.

Admiral investors get the fund for 0.3% -- about one-sixth the cost of the average emerging markets fund.

Fidelity countered by creating Advantage Class shares for its domestic index funds, undercutting Vanguard on fees. Advantage Class shares, available to those with $100,000 in assets, charge just seven-hundredths of a point.

Fidelity has been gradually eliminating loads over the last three years for all its fund investors, a company spokesman said. In mid-2004, it cut management fees on some of its most popular index funds to 0.1%.

T. Rowe Price, another massive fund company, has cut expenses on a handful of funds, regardless of an investor’s balance.

In October, T. Rowe Price cut the expense ratio on its Capital Opportunity fund to 0.95% from 1.15%. Its Global stock fund trimmed expenses to 1% from 1.2%.

In May, T. Rowe Price shaved 0.05 of a point off the management fees for two Treasury bond funds too, said spokesman Steve Norwitz.