Making Sense of Mutual Fund Fees
Following the ruling in Gartenberg v. Merrill Lynch Asset Management, many people look to the six factors discussed therein in determining the reasonableness of fund fees. To recap, the Gartenberg factors are listed below:
- Nature and quality of services rendered;
- Profitability of fund to the advisor;
- Scale considerations that impact the cost of managing a fund;
- Fees charged by peer funds;
- Independence and thoroughness of the board; and
- "Fallout benefits" which indirectly accrue to the advisor because a particular fund exists.
Since no one wants to be in business unless they can earn a risk-adjusted return, it is no surprise that the profitability factor is given considerable weight by investment company directors and advisors alike. For those on the outside however, it is not always an easy task to evaluate any gains or losses realized by one or more invesment companies.
As explained in "Deciphering Fund Fees: Advisors need to understand when fund management fees are excessive" by Sasha Franger (onwallstreet, June 2012), one information source - Lipper's "Investment Management Profitability Analysis" - includes complete data for only public entities. This means that the report reflects data for "26 investment managers representing 23% of the mutual fund industry's assets." Other complexities include the following:
- Not all companies report marketing expenses as a separate item;
- Not all firms report "total revenue" in the same way;
- Some companies included in the study manage a broader array of funds in addition to mutual funds;
- Some companies included in the study offer other services in addition to asset management; and
- Revenue varies by type of funds that an investment company offers.
To better understand the structure and financial conditions for various funds, visit the website for the Investment Company Institute to download the 2012 Investment Company Fact Book: A Review of Trends and Activity in the U.S. Investment Company Industry.
Figure 5.2 shows that expense ratios typically fall as assets under management go up. Figure 5.6 shows a downward trend in expense ratios between 1997 and 2011 for active versus passive funds. Not surprisingly, expense ratios for actively managed equity funds are higher than index equity funds. Figure 5.7 shows that median expense ratios are highest for funds with growth, sector, international equity and aggressive growth investment objectives, respectively.
Given the preponderance of regulated investors such as ERISA pension plans that allocate to members of the $12.97 trillion mutual fund industry and the frequency and severity of 401(k) plan lawsuits that allege "excessive fees," investment company financials are being carefully watched and monitored.
Having worked on fee litigation matters, I would add that a parsing of numbers requires care for various reasons.