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Mutual Fund Fees

The mutual fund industry reports that mutual funds fees (management fees) decrease as fund assets grow. The industry trade group, the Investment Company Institute (ICI), touts a report that shows a reduction in the fees of large mutual funds.[2] ICI reports that funds with over $5 billion in assets charge a fee (0.64%) that is 50% lower than funds with less then $250 million in assets (average fee of 1.25%). Sound impressive? Taking a closer look reveals that a fund with $5 billion in assets charging 0.64% will reap $32 million in fees, while the fund with $250 million in assets charging 1.25% receives only $3.1 million. These mammoth funds have lowered the management fee but are still earning over 10 times the revenue of smaller funds. The actual difference is even larger because large funds average more than $5 billion in assets, while the smaller funds average less than $250 million. Clearly, they could decrease their fees. These figures represent the average fee reductions. Some funds actually increase their fees when they grow. For example, the Lord Abbett Development Growth fund had assets of $446 million at the end of 1997 and charged 1.10%.[3] At the end of 2000, the fund had more than tripled to $1,360 million and was charging 1.20%. One of the largest abuses was by the Munder NetNet fund (mentioned in the previous chapter). At the end of 1997, it had $4 million in assets and charged 1.48%. The fund grew to $2,231 million in three years and charged its investors 1.66%.

In addition, some of the decline in management fees comes from mutual funds in which most investors cannot invest. A class of mutual funds called “institutional” mutual funds grew from 10 equity funds in 1990 to 234 in 1999.[4] Institutional mutual funds limit their customers to other professional investors, like pension plans or investment advisors. The way they enforce this limitation is to enact a minimum initial investment of $500,000, or even $1 million. The mutual funds that most investors can own are called “retail” mutual funds. The average expense ratio for equity retail mutual funds in 1999 was 1.40%, while the expense ratio for institutional funds was 0.88%. Much of the perceived decline in mutual fund expenses in the 1990s can be attributable to the growth of these low-cost institutional funds. Removing the institutional funds from the analysis shows a different picture. The average expense ratio for retail funds in 1995 was 1.37%. Note that the average expense ratio in retail funds actually grew from 1995 to 1999, though not by much.


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