Posted on: Sunday, November 23, 2003

Investors' mutual fund fees excessive

By Aaron Pressman
Bloomberg News Service

Americans who own stock mutual funds are charged annual management fees of about $18 billion, twice the amount they should be paying, according to data shared by state and federal regulators investigating the industry.

Individuals pay $56 in fees for every $10,000 in equity mutual funds, double the $28 paid by institutional investors in stock funds, said John Freeman, a professor at the University of South Carolina and one of the principle sources of data on mutual funds for New York State Attorney General Eliot Spitzer.

Mutual funds "charge whatever they can get away with and nobody has been stopping them," Freeman said in an interview from his office in Columbia, S.C.

Individuals should be paying similar levels of fees as institutional investors, according to Spitzer, who initiated the investigation of the $7 trillion mutual-fund industry in September. Spitzer alleges improper short-term trading of mutual funds helped push up costs for America's 84 million owners of stock funds, whose investments are worth $3.2 trillion according to the Investment Company Institute. An absence of transparency on fees has helped disguise the extent of the wrongdoing, Spitzer said.

"Many funds have abandoned the interests of shareholders," Spitzer said in a statement to Bloomberg News.

Impossible to justify

Stock, bond and money-market mutual funds have more assets than the $5.9 trillion in public and private pension funds combined, and the amount of work involved in managing the accounts is similar, making it impossible to justify the fee differential, Spitzer said.

Management fees charged by the 25 biggest fund managers show Pittsburgh-based Federated Investors Inc. has among the highest fees, collecting an average $83 for every $10,000 in its equity mutual funds, according to data compiled by Bloomberg. Mellon Financial Corp.'s Dreyfus Funds demands $80.

Average stock-fund fees aren't "meaningful," Federated spokeswoman Meghan McAndrew said. Investors use other factors to pick funds, including analysis of long-term performance, a money manager's reputation and how a particular fund fits into an overall portfolio, she said.

On Nov. 13, Spitzer criticized the Securities and Exchange Commission's partial settlement with Putnam Investments because it didn't require the company to admit guilt, or address fees. Most equity mutual funds were created during the bull market of the late 1990s when commissions were overshadowed by average 24 percent annual returns of the Standard & Poor's 500 Index.

Lower fees

Putnam has charged individual owners of its International Capital Opportunities mutual fund $91 per $10,000 invested. Putnam charged the state of Massachusetts $27 per $10,000 invested in international stocks for a $1.1 billion account.

"Lowering fees is inevitable," said William Patterson, a director of investment at the AFL-CIO, which represents 65 labor unions with 13.2 million members. "This is all to the good. This is an industry which had a pass for many years."

The SEC, along with Spitzer and other state regulators, is examining whether returns for long-term investors have been reduced by improper short-term and after-hours trading by privileged clients.

Putnam, Alliance Capital Management Holding LP, Strong Capital Management Inc. of Menomonee Falls, Wisconsin, and Denver's Janus Capital Group Inc. are among firms being probed.

Greater disclosure

So far, there's little evidence of investors abandoning stock funds. An estimated $5.4 billion a week poured into equity funds in the four-week period ended Nov. 12, a survey by AMG Data Services of Arcata, Calif., said. The pace of inflows was the fastest since May 2001, following a 19 percent increase in the S&P 500 Index this year.

Lawmakers are pushing for legislation requiring fund companies to more clearly disclose the commissions that they charge.

"If you really look at the fee structure of the industry, you'll see that the fees are very high," Sen. Peter Fitzgerald, R-Ill., said at a Senate subcommittee hearing. "We need to fix that."

Fund companies respond that management fees they charge include more services, like sending reports to shareholders, than those charged for pension-fund management.

Vanguard Group of Valley Forge, Pa., charges the lowest stock-fund fees among the 25 biggest companies — $27 per $10,000 invested, according to Bloomberg data. The management company is owned by shareholders, unlike most of its competitors, allowing for lower expenses, said Michael Miller, managing director for planning and development at Vanguard.

A proposal from Spitzer that mutual funds put clauses in contracts with advisory and management companies to prevent the managers from charging fees above those charged to pension funds would make "a whole lot of sense," said Fitzgerald.

"If investors feel the game is rigged, they will avoid the playing field and park their money on the sidelines," said Rep. Richard Baker, R-La., in testimony to a Senate subcommittee on Nov. 3.