A news release said the Zero Alpha Group (ZAG) study of over 5,000 equity offerings found that 46% of all small cap funds have “all-in” trading costs that are higher than the annual expenses investors pay. Some 21% of mid cap funds fall into that category as do 7% of all large cap funds, according to the announcement. In the small-cap category, 17% of all funds have implicit trading costs that are twice the level of annual expenses.
The ZAG study, entitled Portfolio Transactions Costs at US Equity Mutual Funds, also concludes that growth funds have higher than average trading costs as a percentage of annual expenses: The growth funds are broken down into large cap growth (with trading costs averaging 43.1% of stated expense ratios), mid-cap growth (86%), and small-cap growth (123.2%). Hidden expenses for value funds are lower than with growth funds, the study found.
One of the starkest conclusions from the study was the difference in trading costs between index funds and actively managed funds. The total trading costs of active funds were 0.48 % per year. The trading costs of index funds averaged 0.064% per year.
In terms of study procedure, the ZAG study examined explicit and implicit trading costs. The explicit trading costs are brokerage commissions that funds pay to effect trades for their portfolios. Information was collected on the actual commissions paid for the sample of mutual funds for fiscal year 2002.
Meanwhile, according to the news release, implicit trading costs include bid-ask spreads and market impact costs that are more difficult to quantify. Researchers calculated the costs by estimated of per-trade implicit trading expenses for institutional investors to the reported mutual fund turnover rates of the sample. The study then combined the explicit and implicit costs and compared the “all-in” number to reported annual fees, the announcement said.
The research was conducted by Edward O’Neal, assistant professor of finance at the Wake Forest University Babcock Graduate School of Management, and Jason Karceski and Miles Livingston at the University of Florida.
The study is at http://www.zeroalphagroup.com . The Zero Alpha Group is a nationwide network for eight independent investment advisory firms that manage a total of more than $3 billion in assets.