Monday Morning: Mutual fund industry in (fee) denial

When it comes to fees, the mutual fund industry is swimming against the tide, and it’s the shareholders who are getting soaked.

At a time when everyone from auto salesmen to travel agents is under intense pressure to discount prices, the fund industry remains intent on keeping fees exactly where they were in the heady days of the late 1990s.

In fact, there’s solid evidence suggesting that many funds have actually hiked fees as returns have headed south.

The industry’s fee structure is disconcerting and completely out of touch with the economic realities facing investors. In an era of single-digit – or even negative – returns, what a fund charges may make the difference between whether an investor makes or loses money in a given year.

The current structure also does little to restore investor confidence in corporate America. The fund industry has tried to distance itself from recent corporate controversies by claiming that it has operated “scandal free” for decades.

That claim to fame is being put to the test by allegations made last week by New York State regulators that several top fund companies earned profits by allowing a hedge fund to improperly trade fund shares to the detriment of other fund investors.

unrealistic expectations

Even if those allegations prove untrue, or exaggerated, the fund industry certainly could have been more aggressive about managing investor expectations during the bull market.

Instead, they stoked unrealistic expectations by launching expensive funds aimed at the latest hot sector.

Like cigarette manufacturers who preach the perils of nicotine addiction as millions of cigarettes roll off their assembly lines, fund companies warn against chasing short-term performance while pumping out funds aimed at appealing to investor greed.

By not cutting fees, the industry is refusing to acknowledge its role in the losses experienced by many investors in recent years. Even worse, it compounds the distrust fostered by Wall Street’s well-documented shenanigans.

If nothing else, fund companies should at least tie their fees more closely to performance. That way, their interests are more aligned with investors’.

The fund industry says it’s sympathetic to investors’ plights. It feels their pain, it says.

But should fund companies feel pressured to lower prices? After all, it’s not as if the fund industry caused the three-year stock market downturn.

“The expenses associated with providing the ongoing activities of investing don’t get reduced or eliminated simply because market returns are weak,” says John Collins, a spokesman for the Investment Company Institute in Washington. “Should [fund companies] stop paying their employees? We think not.”

Mr. Collins says that fund companies are quite competitive on expenses. That’s because a fund’s performance is net of expenses, which means that more-expensive funds get penalized on the performance end. And everyone knows that investors are as fond of higher-performing funds as Madonna is of publicity stunts.

it’s about time

Regulators and politicians are now reviewing whether fund costs are too high and are asking if fund companies should do a better job of disclosing them.

Roy Weitz, editor of the Tarzana, Calif.-based newsletter FundAlarm.com, says such scrutiny is long overdue.

“In good times and bad times, the fund industry remains one of the most profitable in the country,” he points out.

Frederick P. Gabriel Jr., a reporter in the Boston office of InvestmentNews, covers the mutual fund industry.