Mutual Fund Fees Debate: Much Ado About Nothing?

mutual-fund-fees-fight-may-be-much-ado-about-nothingD. Bruce Johnsen, a professor of law at George Mason University in Arlington, Va., likes to keep things simple. Explaining the conclusions of his recent study, Myths About Mutual Fund Fees: EconomicInsights on Jones v. Harris, he says bluntly: "Lower advisory fees don't necessarily benefit investors."

"Don't believe the bad press about high advisory fees," he adds. "It's a misconception that fund fees necessarily reduce investor returns dollar for dollar, and that lower fees therefore benefit investors."

Robert Isbitts, chief investment officer with Emerald Asset Advisors, puts it another way, "Most often, you get what you pay for."

Conventional wisdom goes something like this: If underlying costs for management, distribution, operations and administration are at the low end of the spectrum, then it must be good for investors. But Isbitts' own research of 34 categories of mutual funds nearly two years ago showed that the ten best performers were also among the most expensive. "If you want skill, don't be afraid to pay for it."

Higher prices in many settings are a credible signal of high quality, says Johnsen. "Suppose you really like oysters, and someone tells you there is a sale on oysters, five for a dollar, would you buy and eat them? I hope not," he adds.

Higher Fees Don't Always Mean Higher Returns

There's no shortage of opinion on mutual fund fees. Plenty of investors subscribe to the school of thought that fees do matter when it comes to returns. "The fact that mutual funds offer shares of different classes with different fee arrangements for managing the same portfolio is almost conclusive evidence by itself. On Monday, the U.S. Supreme Court heard arguments in Jones V. Harris Associates, in which it is charged that retail investors paid higher management fees than institutional investors with respect to the management of identical portfolios. Surely, higher fees diminish investment returns," says Roger Levy, CEO of Cambridge Fiduciary Services.

In any given asset class, it is entirely possible that higher fees do not translate to higher returns, says Padma Kadiyala, associate professor of finance at Pace University's Lubin School of Business. "That is, within the category of high-yield bond funds, it may no longer be true that a fund that charges a higher fee earns a higher return for its investors.

Even Isbitts admits that in large-cap stock funds, for example, there may not be much added value with a higher fee. "It's with smaller cap and world allocation mutual funds, for example, where higher fees reflect added value,"says Isbitts.

First Look for Talent, Then Calibrate Fees

Some would argue that international, emerging market and other specialty-sector funds require more in depth research and therefore should be more expensive. "You have to pay for talent," says Jim Scheinberg, managing partner of North Pier Fiduciary Management. A manager's prowess could be linked to the resources they expend, thus impacting their costs and net fee. For example, if one small-cap manager has three analysts for a $500 million portfolio and one manager has 10 for the same sized portfolio, the second manager's costs, and the resultant fees, are going to be higher; but in theory, their coverage of their market should be better. "Would this justify a higher fee? If their performance was stronger, we think so," says Scheinberg.

All the fuss over fees may be a bit misdirected. "They matter, but not as much as many would lead you to believe," says Adam Bold, author of The Bold Truth About Investing. "If a fund manager can deliver results that are superior to another manager with a fund that has lower expenses, I would go with the fund that offers better returns. If I had two funds that I like equally, and one has lower fees, I'd choose that one. It's less of a hurdle the manager has to jump over at the beginning of the year to get even."

Ultimately, he says, "It doesn't matter how much you pay the fund. What counts is how much the fund pays you."

Read Full Story