ICI: Mutual Fund Fees Down…For Now

The aptly (if somewhat inartfully titled, “Trends in the Fees and Expenses of Mutual Funds, 2008” claims that investors paid 99 basis points, on average, to invest in stock funds, a 2 basis-point decline from 2007.   Average fees and expenses on bond funds dropped 3 basis points to 75 basis points, according to the report, while fees and expenses on money market funds averaged 38 basis points.

However, it should be noted that, in order to summarize the fees and expenses that shareholders incur, ICI uses an asset-weighted average.   Additionally, ICI says that in order to “assess appropriately the fees and expenses incurred by individual shareholders in long-term funds, the analysis includes both retail and institutional share classes of long-term mutual funds.”

Tracking Target-Dates

ICI notes that the market for funds of funds – mutual funds that invest in other mutual funds – has

expanded considerably in recent years.   In fact, ICI said that by the end of 2008, there were 865 funds of funds with $490 billion in assets, and that over 80% of the assets of funds of funds are in hybrid funds of funds, which are funds that invest in a mix of stock, bond, and hybrid mutual funds.   Much of that growth, in turn, stems from investor interest in lifecycle and lifestyle funds, according to the ICI.   The report noted that lifecycle and lifestyle funds have proven to be especially attractive for individuals saving for retirement in 401(k) plans and IRAs, and that lifecycle and lifestyle funds account for 62% of the total number and 65% of the total assets of funds of funds.

Considering the growing use of these funds of funds, ICI notes that from 2005 to 2008, the average expense ratio of funds of funds fell from 99 basis points to 92 basis points, a drop of 7%.   ICI said that that drop “may reflect competition among an increasing number of funds of funds for investors’ dollars”, and that, with the assets of funds of funds up 60% since 2005, “scale economies may have played a role.”

Declining Values = Higher Expense Ratios?

The report did, however, caution that recent drops in asset values could result in a reversal of that trend.   "No such increase in fund expense ratios is evident in this paper, but experience from past market cycles indicates that a rising trend is possible," according to the ICI.   "During the market downturn that lasted from early 2000 to early 2003, for example, average expense ratio of stock funds rose several basis points."

The ICI outlined a number of reasons why declining assets might lead to rising expense ratios:

Some fund expenses are relatively fixed, including transfer agency fees (which tend to be charged as a fixed number of dollars per account), the cost of mailing fund literature, accounting and audit fees, and director fees.   "When fund assets fall, these fixed costs will rise as a percentage of assets, tending to boost a fund's expense ratio," according to ICI.

Some fund complexes offer "breakpoints" in the management fee that they charge their funds. Such a fee structure reduces the fee rate as the fund's assets grow, sharing with investors the benefits of economies of scale - but as asset levels fall, the fund may lose some of the benefit of those reduced rates, resulting in a higher expense ratio, according to the ICI.

However, ICI notes that any potential increases in expense ratios as the result of these factors should be distinguished from increases in the contracted schedule of fund management fees, since any increase in the fee schedule would have to be approved by fund directors and shareholders.  

Finally, ICI notes that the expense and other fee information used in this article are based on 2008 data, and thus do not reflect any fee changes occurring in 2009. Also, the fee data used in the article were based on funds' fiscal years, which may or may not align with the calendar year.

The report is online at http://www.ici.org/home/fm-v18n3.pdf