In a recent Wall Street Journal Op-Ed article by Vanguard founder Jack Bogle, he reaffirmed studies like the one from Morningstar showing that one of the strongest predictors of mutual fund performance is how low their annual expense ratios are. In addition, he shared data that fees on actively-managed funds continue to rise despite increasing asset sizes:
Conclusion: The huge economies of scale available in managing other people’s money have largely been arrogated by fund managers to their own benefit rather than to the benefit of fund shareholders.
In a letter to the Editor, Neil Hennessy, president and chief executive of fund manager Hennessy Advisors Inc. shot back, listing his own reasons for keeping his fund fees north of 1% (100 basis points) annually.
For one of our typical funds, federal and state registration fees have increased 44%, legal fees have increased 73%, and audit fees have increased 30%. […] Also, while no-transaction fee platforms didn’t exist in the 1960s, today funds pay as much as 40 basis points to be on the platforms offered by the likes of The Charles Schwab Corp. and Fidelity Investments.
According to this Investment News article, other mutual fund managers also feel this way.
His grievances are shared by many in the fund industry, said Don Phillips, a managing director at Morningstar.
“I think a lot of people would be afraid to do what Neil did and that is to out the distributors,” he said. “The asset managers are taking all the blame for high fund expenses, while the distributors are completely off the radar.”
I thought this was an interesting debate. I had no idea it cost that much for smaller mutual funds to get the accessibility of being part of a mutual fund “supermarket” like Schwab or Fidelity. However, that cost does allow investors to buy the funds with no transaction fee (NTF) at these places, which no doubt encourages more activity. In the long run though, 40 basis points is a huge ongoing drag. Here is an old 2004 Forbes article I found on fund supermarkets that also confirms the 35-40 basis point number.
I logged into Fidelity and found that all 10 non-institutional Hennessy retail funds were on the Fidelity NTF list. However, their expense ratios were also in the 1.30% to 1.70% range – well above average even for active funds. Hennessy isn’t exactly doing all they can to save money for the investor.
It would be nice if smaller mutual funds had a more open marketplace to distribute themselves, since it would seem a huge percent of their cost is just marketing. Of course, that’s also true for a lot of other things we buy, from breakfast cereal to basketball shoes. At the very least, an investor should always try to buy direct from the fund provider whenever possible.
In the end, I’m happy that I can buy most of my mutual funds “wholesale” from Vanguard with their at-cost philosophy, along with some “loss-leader” index funds from Fidelity. Shop smart!
Hat tip to Barry Barnitz of Bogleheads.