Commentary: Fund Fees Are Rising. Who's To Blame?

When your mutual fund was soaring 20% or 30% a year, did you care whether its expense ratio was higher than it should have been? Probably not. But as investors open statements and see the bear's paw, which in the past quarter slashed the average stock fund's value by 15%, the ever-rising fees will grate. Why pay extra to a manager who's making you poorer?

In the industry's view, the complaint that average fund expenses keep rising when economies of scale should send them falling doesn't give the whole story. Investment Company Institute President Matthew Fink on Sept. 29 told a congressional subcommittee: "The average shareholder account is in a mutual fund whose annual fees are 36% lower than the simple industry average....This indicates that the market readily enables investors to own lower-cost mutual funds."

What Fink said is true as far as it goes. Yet it skirts the key question: What about those unlucky investors who pay higher-than-average expenses? Who's looking out for them? This wouldn't matter if the relationship of investor to mutual fund were akin to, say, a bank customer to a checking account. A fund investor, however, is not a customer but an owner, with say over how the fund should be run--a crucial distinction made explicit in the law. Also spelled out is the protection a fund's investor-owners are supposed to receive from independent directors who sit on every fund's board. Neither paid by nor otherwise obliged to the investment adviser, the directors have a fiduciary duty only to the fund's investors and not to Fidelity, Vanguard, or any other fund company. If expenses are too high, it's the independent directors who have failed.

Too few investment pros, let alone individuals, appreciate this difference. So here's a modest proposal: Fund companies should cast a brighter spotlight on the role of independent directors. Inform investors better about who the directors are and how they can be contacted. Explain their responsibilities. Disclose more often how much they earn and how many fund shares they own.

Not many investors understand how fees are set, much less to whom they should complain. Funds must disclose directors' salary data only in an annual "Statement of Additional Information," an exotic document every investor is entitled to, but few know to ask for. Why not describe the directors' role, list them, and detail how they may be contacted in the prospectus everyone gets?

Whether a director owns shares in a fund can be found only in proxy statements funds issue irregularly, and then only if the directors as a group own more than 1%. Years can go by between proxies. Instead, why not report that data more often, perhaps in the prospectus?


Better disclosure entails a cost that must be weighed against the benefits, of course. "There are a million things a million different people would like to see in a fund's prospectus," the ICI's Fink notes. But few are more important than specifying who speaks for the fund owners and how they might serve their fellows. That's the essence of representative democracy, and it can be achieved at no real cost. Data on directors now is disclosed only "if you can follow the treasure map and find the secret answer," notes Harold Evensky, a financial planner in Coral Gables, Fla., who also testified before Congress.

Don Phillips, president of the investment-research firm Morningstar, thinks fund directors do keep the industry close to the straight and narrow. "But," he says, "it's hard to argue that driving costs down is a preeminent" concern of theirs. Tightening the tie between those of us who own funds and our director-representatives can only help to put expenses near the top of the agenda.

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