Fed-up fund-watchers confront a rise in fees
John C. Bogle is often seen by the mutual-fund industry as a big nuisance. He admits it himself. "A pain in the neck," says the founder and former chief executive of the Vanguard Group, one of the nation's largest mutual-fund organizations.
That's because Mr. Bogle is drawing attention to what he regards as excessive sales loads, fees, and other expenses charged to mutual-fund shareholders by fund-management firms.
During the 1990s bull market, these costs got little attention. Most shareholders of funds invested in stocks were getting rich, at least on paper, and weren't particularly bothered if the managers and others in the industry were raking in the dough in grand style.
Besides, as Bogle notes, the 95 million fund shareholders in the United States "are largely unaware of the high level of mutual-fund costs."
With the stock-market bubble burst, the mutual-fund industry has come under a harsh spotlight it hasn't seen for years, if not decades.
Bogle is partly responsible. In speeches, congressional testimony, books, and frequent press interviews, he repeats his calls for reform in the fund industry.
Changes to reduce mutual-fund costs will require "a long battle," Bogle says.
Nonetheless, this former industry insider already has the attention of Congress and, indirectly, the industry's regulatory agency, the Securities and Exchange Commission (SEC).
A subcommittee on capital markets of the House Committee on Financial Services held a hearing March 12.
"Are investors getting a fair shake?" asked Rep. Michael Oxley, chairman of the full committee. And then the Ohio Republican answered himself, "No."
A study by the US General Accounting Office found that the average expense ratio for 46 large stock funds rose from 0.65 percent of assets in 1998 to 0.70 percent in 2001. The same ratio for 30 major bond funds fell from 0.58 percent to 0.54 percent in the same period.
Funds normally charge shareholders a certain percentage of assets as a management fee, a percentage that may decline if total assets exceed a certain level.
In the case of stock funds, the increase partly reflects the fall in stock prices, and thus in fund assets. For both the stock and bond funds, the average expense ratios are lower than in the early and mid-1990s.
Using a different methodology that includes sales charges, the Investment Company Institute, representing mutual-fund management firms, found that "total shareholder costs" for equity funds fell from 2.26 percent of fund assets in 1980 to 1.28 percent in 2001.
"The cost of mutual funds is lower - far lower - than the cost of other financial services or products available to Americans," said Paul Haaga, ICI chairman.
Bogle isn't impressed. He says shareholder costs are more than 100 percent higher than the ICI estimates, if portfolio-trading costs and other costs are included.
Also, mutual-fund assets were $2.5 billion 50 years ago, he notes. They had grown to nearly $7 trillion at the end of 2001. So costs per share for big funds should be lower, thereby giving shareholders a higher return.
Typically, costs can take 20 percent of the return provided by the stock market and 80 percent of dividend income collected by the fund, Bogle calculates.
Another Bogle point is that the Investment Company Act of 1940, which set rules for mutual funds, specified that fees be "reasonable" and that directors of mutual-fund companies should place the interests of shareholders above the interests of investment advisers and distributors.
"The law does not say they can charge whatever the market can bear," says Bogle. They should not leave fees to the "wiles of the competitive marketplace."
The independent directors of a fund have the responsibility to obtain the best possible investment manager and negotiating with that manager the lowest possible fee. But their record, states famed investor Warren Buffett of Berkshire Hathaway in its latest annual report, "has been absolutely pathetic.
"For the most part, a monkey will type out a Shakespeare play before an 'independent' mutual-fund director will suggest that his fund look at other managers, even if the incumbent manager has persistently delivered substandard performance."
These directors have "failed miserably" in seeking lower fees, Mr. Buffett charges.
As a partial remedy, Bogle suggests the SEC require the chairman of a fund's board be an independent director, rather than, as is typical now, the head of the management company, an officer who profits from high fees.
Bogle also calls for the minimum proportion of independent directors to be raised above the current 50 percent level. And these independent directors should have an independent source of information on the performance of the fund, as well as a report from management itself.
As for shareholders, Bogle would like them to get much more information on performance and costs printed on the inside cover or third page of fund reports.
The House subcommittee chairman, Rep. Richard Baker, recently wrote to the SEC for reports on such topics as fees, costs, and portfolio-manager information.
Spokeswoman Peggy Peterson calls this the "beginning stages" of an investigation.