This was the contention made by Lipper’s Senior Research Analyst Don Cassidy in the report “Mutual Fund Trading and Portfolio Transaction Costs.” Cassidy found that mutual funds are utilizing ” exceptions to the usual commission-disclosure routines” that “apparently create convenient loopholes for funds, effectively allowing them to say they cannot calculate total commissions costs because they do not know the commission on every single transaction.” Thus investors that rely on the “total expense ratio” are only seeing part of the picture.
As the regulations are currently written, a mutual fund is only required to report a total expense ratio composite ofthe proportion of a fund’s assets consumed by all annual costs accrued by the fundin percentage format, while information such as the amount a fund paid in commissions is reported in fund annual reports in terms of gross dollars paid. Yet, Cassidy says such disclosure does little to reveal the drag on a mutual fund’s performance the commissions being paid for transactions cause. This is true because, if for nothing else, because the “typical mutual fund investor does not make the effort to calculate their size relative to the assets of the fund.”
Evidence of Cassidy’s contention is found in a roughly 20 basis point drag (19.3) on performance among equity funds from commissions alone, a number of that goes up to a drag on performance of 20.2 basis points for actively managed funds, which account for nearly 89.1% of investors’ assets in conventional equity mutual funds. This drag on performance cuts across all styles, as the research firm found no evidence of “a sharp delineation of average commissions drag on the style or capitilizations vectors of the 12 cell US Diversified Equity matrix.” Overall, the research paper found nearly 200 mutual funds with a drag on performance exceeding 100 basis points, with “several dozen individual cases” where the drag on commissions was actually higher than the total expense ratio reported by the fund.
Given this lack of disclosure, Cassidy finds the average mutual fund investor, who “is not a tax accountant,” is making decisions to buy, sell or hold mutual funds on an incomplete picture.
“We believe investors deserve prompt and full transparency on commissions drag since it affects performance – and since drag is surprisingly large in many cases,” the study asserted. To achieve this disclosure, Lipper says the drag commissions paid by funds for the buying and selling of securities cause on the overall fund’s performance should be disclosed in a percentage or basis point figure – ostensibly a “total expenses and commissions ratio.” Further, the disclosure should “occur in a very prominent location in both the prospectus and annual report,” the report said.
However, the effect of this added disclosure though may be muted by the average investor’s own negligence, Cassidy admits. ” We realistically question whether most investors read, and how many actually understand, much of what is already disclosed in fund documents.” Yet, this is not reason for the non-disclosure Cassidy says as “the added more-accessible information will be useful to some … and that is good enough reason in our view.”
A copy of the complete report can be found at www.research.lipper.wallst.com . More information is also available by contacting Lipper at (877) 955-4773.