A Supreme Court ruling expected this year on the standards that courts use to determine when mutual fund fees are excessive, and a renewed focus by the SEC on 12(b)-1 fees, guarantee that the mutual fund industry will spend a good deal of time debating fees in 2010.
It's a debate, however, the industry would rather not have.
That's because such discussions highlight the fact that mutual funds are generally more expensive than exchange-traded funds.
As a result, “ETFs will continue to take market share from mutual funds,” said Mark Balasa, a financial adviser and co-president of Balasa Dinverno & Foltz LLC, which manages $1.5 billion in assets.
Assets in ETFs had increased by 30.13% to $691.39 billion at the end of October, from $531.29 billion at the end of 2008, according to the Investment Company Institute.
Over the same period, assets in all mutual funds — including money market funds — increased just 11.35%, to $10.69 trillion from $9.6 trillion, according to the ICI.
But while the disparity in fees may help ETFs continue to pull in assets, the ruling from the Supreme Court is expected to favor the fund industry.
The case, Jones v. Harris, involves a lawsuit filed by a group of investors against Harris Associates LP, which advises the Oakmark Funds. The plaintiffs allege that Harris breached its fiduciary duty by charging excessive management fees.
The 7th U.S. Circuit Court of Appeals ruled against the plaintiffs in 2008.
Chief Judge Frank Easterbrook upheld the fees set by Harris and noted that as long as there is transparency and no fraud has been committed, a fund provider hasn't breached its fiduciary responsibility to investors.
That ruling essentially created law.
Since a 1982 ruling by the 2nd U.S. Circuit Court of Appeals, courts have applied the Gartenberg standard — named for a plaintiff in that case — to claims of excessive fees.
Mutual funds are content with the Gartenberg standard — it makes it virtually impossible for investors to win excessive-fee cases — and that's the standard many industry watchers believe will prevail.
“Predicting Supreme Court decisions is a risky business, but I expect what will come out of this is an expanded version of Gartenberg,” said Burton Greenwald, a mutual fund industry consultant.
Predicting whether there will finally be true reform of Rule 12(b)-1 of the Investment Company Act of 1940 is just as tricky.
Reforming the rule had been a front-burner issue because critics contend that the primary use of the mutual fund fee has shifted from paying for fund marketing to substituting for a sales load.
But a multiyear effort to reform Rule 12(b)-1 was put on hold as the Securities and Exchange Commission struggled to deal with the recession.
SEC Chairman Mary Schapiro, however, renewed calls for the reform of 12(b)-1 fees last month.
This time the commission may be successful, but it may not be the kind of success desired by those who would like to see the rule repealed.
“It seems pretty clear there will be a major change in 12(b)-1,” Mr. Greenwald said.
The debate over fees, however, isn't expected to consume all the attention of mutual fund companies.
When March rolls around, giving mutual funds a full year of good returns to boast about, mutual fund firms are expected once again to advertise in earnest, said Howard Schneider, president of the consulting firm Practical Perspectives.
“We're already starting to see advertising come back,” he said.
As for product innovation, the mutual fund industry will likely continue to focus on income-oriented investments intended to meet the income needs of retiring baby boomers, Mr. Greenwald said.
“You're going to see more crafting of products to provide an income stream at retirement,” he said.
Beyond that, however, don't expect too many new products, Mr. Schneider said.
The investing public is leery of jumping into anything new after coming through one of the worst recessions in history, he said.
E-mail David Hoffman at [email protected].
