Mutual fund fees as a percentage of assets are down, but not enough to the New York Times and Saint Jack. Kelly Clarkson must've been talking about fundsters when she sang "You Can't Win."

Over the weekend the NYTimes' Jeff Sommer posted an article about how the average expense ratio paid by mutual fund investors has fallen over the past decade. Yet the paper still takes the mutual fund industry to task for fees, noting that the main driver of the drop, according to new research from Morningstar, is investors voting with their feet by shifting their money into cheaper funds, and not mutual fund shops lowering fees on specific funds.

"That drives down the asset-weighted cost of mutual funds, skewing the statistics," the NYTimes writes.

The article also points to "an unpublished study by the Bogle Financial Markets Research Center," a study that found 95 of the 100 lowest-cost funds (as of March were index funds. And it cites Vanguard founder and ex-chief Jack Bogle himself, who follows his traditional anti-fundster attack by claiming that "most fund companies aren't passing those savings [from economics of scale] on to investors." He suggests that fundsters charge only a flat fee for each portfolio, instead of basis points, to pass along even more savings to investors.

Saint Jack might be right about the importance of low costs and about the difficulties of consistently outperforming the market, but at the same time he's talking his business. And his suggestion that funds only charge a flat fee, instead of an asset-based one, would remove the alignment of fund shop and fund investor interests that comes with asset-based fees, even low ones; when the fund grows, thanks to more investors buying shares or thanks to its investments doing well, both the investors and the fund firm benefit. When the fund's assets fall for one reason or another, investors can, as the NYTimes notes, vote with their feet and jump elsewhere, adding insult to underperforming injury, and the fund firm takes a revenue hit.

Take away asset-based fees, and keep the asset-based liabilities (if something goes wrong with $10 billion fund, it costs much more to fix than with a $100 million fund), and well, it starts to sound like a losing proposition to run a large mutual fund. Where's the upside? And if fundsters were to try to keep funds small, well, they'd never reach the economies of scale that the NYTimes and Bogle want the funds to use to pass along savings to investors.

The paper also brings up "the equal-weighted expense ratio" for the industry, in contrast with the asset-weighted expense ratio, and notes that the former is much higher (nearly double, in fact: 119 bps versus 64 bps). But doesn't that just mean that the expensive funds aren't attracting assets, so investors by and large aren't falling for them.

And the numbers cited by the paper actually show that, despite the fund industry's revenue being asset-based, fees have increased at half the rate that assets have. Last year the industry (mutual funds and ETFs combined) brought in $88 billion, a record high, up more than 75 percent over a decade. Yet AUM rose 143 percent over the same period, and the asset-weighted average expense ratio fell 27 percent. So, assets more than doubled, but total fees didn't, thanks to investors rewarding lower cost fund firms (Vanguard among them, but others, too). What's the problem here again? 

Edited by: Neil Anderson, Managing Editor


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