As Funds Jockey For Investors, Fees Climb Higher
Fund watchers advise people to shop around for low-cost, low-fee mutual funds
MANY mutual-fund investors, distracted by good returns, may not have noticed that their bottom line is being affected by something else: rising fees.
The increase in expenses stems partly from stepped-up competition, both within the industry, and between mutual-fund companies, banks,and other financial-service firms. That means higher costs for fund promotion and payrolls.
Some fund companies have reacted by trying to reverse the trend. Calvert Group, a mutual-fund company based in Bethesda, Md., looks for ways to reduce shareholder costs.
The company, which issues 25 mutual funds, has watched fees gradually inch upward throughout the industry in recent years, as expenses such as advertising and salaries have risen.
Undaunted, Calvert "is determined to hold down costs," says Steve Schueth, a spokesman. Calvert funds, for example, are known for their use of "socially responsible" investing screens - that is, selecting companies based on social considerations.
"Yet, we don't pass any of the costs of that screening process along to our customers," Mr. Schueth says. "Nor do we pass along normal office expenses, such as salaries, heating, light."
The result, Schueth says, is that Calvert's overall expense ratio is less than 1 percent, relatively low by industry standards. One factor helping Calvert: The company has several large money-market funds, which traditionally have lower overhead costs than equity or bond funds.
A few other firms are also attempting to hold down charges. And the industry's low-cost leader, the Vanguard Group, continues to do so. Vanguard recently announced that it was slashing its fee structure by an amount totaling nearly $10 million annually.
To maximize their returns, investors need to look for ways to lower their fund expenses.
Typically, annual expense ratios for mutual-fund sectors average around 1.5 percent a year for equity funds, just under 1 percent for bond funds, and around 0.6 percent for money-market funds, according to Beth Kobliner, author of "Get A Financial Life" (Simon & Schuster), a new advisory book for investors in their 20s and 30s.
"The mutual-fund industry is taking advantage of the individual investor through the use of adding on more and more fees," asserts Herbert Ringold, a critic of mutual-fund fees. He takes the industry to task in a new book, "The Real Truth About Mutual Funds," issued by a division of the American Management Association in New York.
The main culprit, Mr. Ringold says, is the 12b-1 rule, a federally approved fee adopted by the US Securities and Exchange Commission in 1980 that allows mutual funds to charge off distribution costs.
Each fund's prospectus outlines 12b-l fees, and how they will be treated, if applicable. Some funds, for example, assess charges monthly.
12b-1 fees too broad
Ringold believes that fund companies have twisted 12b-1 to "include almost everything you can come up with." In addition, many funds also ring up redemption fees, charges for reinvesting dividends, the exchange fee (to switch funds from one fund to another), a close-out fee, an opening fee, and a minimum-balance fee. Ringold urges investors to shop for low-cost funds and to avoid funds using the 12b-1 charge.
"The total expense ratio [for mutual funds] is up over the past few years, driven largely by higher distribution costs, which are reflected in 12b-1 fees, and higher transfer costs," says Jeffrey Keil, assistant vice president at Lipper Analytical Services Inc., a New York company that tracks fee schedules.
Distribution costs, Keil says, include advertising programs and promotional materials; transfer costs include fees on a greater range of shareholder services, such as customer information hot lines. Portfolio managers are also demanding higher pay, he says.
Late last year, Fidelity Investments in Boston began imposing a new $12 annual maintenance fee on accounts of less than $2,500. Fidelity's reason, says a spokeswoman, was to better allocate maintenance costs among all shareholders.
Funds companies maintain that their fees are essential to provide adequate research and cover costs and profits.
"Companies are having to add more specialists as they buy more exotic products, such as derivatives and overseas stocks," Keil notes.
The gradual rise in fees can be measured by taking the most prominent sector of funds - general equity funds.
For all stock funds, the median expense ratio for the 12-month fiscal year ended Nov. 30, 1995, was 1.27 percent, Keil says. That is up from 1.229 percent for the fiscal year ending Nov. 30, 1994, and up from 1.199 percent for the same period in 1993.
Some fees remain steady
Bright spots, in terms of lower or steady fees, include world equity funds and money-market accounts, Keil says.
Although fees on world funds rose slightly in 1995, they tend to be generally low, Keil says, reflecting intense competition within the industry. Money-market fees have generally remained low, less than 1 percent.
Will fees continue to climb? Yes and no, reckons Keil. Independent distribution channels for mutual-fund companies, such as through discount brokers, remain expensive, he says. Still, Keil believes expenses will gradually ease downward later in the decade, given rising competition.
Experts advise investors to be alert to hidden costs such as trading commissions on securities in the fund portfolio. These are are deducted from a fund's assets. Morningstar mutual-fund reports, available in many public libraries, identify trading costs on funds. Also, each Friday's Wall Street Journal lists fund expense ratios.