In recognition of your tenacity during this long bear market, we at (insert Mutual Fund Company Name here) have decided to cut the cost of all our equity funds, effective immediately. We know that many of you have lost significant sums. Reducing the expense burden of your investments is the least we can do.
You will see this cost reduction reflected in your next quarterly statement.
Your Friendly Mutual Fund Company
If you received a letter like that you would have to treat it for what it is--- an April Fool's joke--- because mutual fund fees are going up, not down. Faced with major declines in assets, mutual fund companies are increasing what they charge investors. To be sure, this is not universal--- some funds have reduced expenses--- but the broad direction is up.
The most conspicuous example is Fidelity Magellan fund. Until recently the mother of all mutual funds led the field. It had as much in assets as many fund companies have in all of their funds. Peaking at over $100 billion in 1999, the fund finished the year with an expense ratio of 0.62 percent, literally half the expenses of the average "large blend" fund.
Three years of bear market later; Magellan's assets have been cut in half. Its expense ratio has risen to 0.78 percent a year, a whopping 26 percent increase. During the same period its large blend peer group has increased expenses from 1.20 percent to 1.26 percent, an increase of only 5 percent.
As a practical matter, the Magellan expense increase amounts to a surcharge on the nations retirement plans. Fidelity is the single largest provider of retirement plans. Some 8.3 million 401(k) participants and 1.8 million 403(b) and 457 plan participants have their money in Fidelity retirement plans.
Retirement plans, in turn, account for 78 percent of Magellan fund assets. When Pensions and Investments, an industry trade magazine, listed the biggest funds in defined contribution plans at the end of 1999, Magellan topped the list with $69.1 billion. The amount dwarfed the $26.6 billion in the Vanguard 500 Index fund, the next largest competitor.
After the last three years of underperformance, Fund Alarm ranks Magellan as a "two-alarm" fund. Fund Alarm is non-commercial website that rates fund performance. Magellan has failed to beat its benchmark for two of the last three measuring periods.
Fidelity Contrafund, the second largest equity fund at Fidelity and the third largest equity fund in defined contribution plans, also saw a major increase in its expense ratio. It went from 0.65 percent to 1.03 percent, an increase of 58 percent. Unlike Magellan, this fund remains a top performer. David Vance, a Vice President in investment management at Fidelity, points out that part of the Contrafund expense increase is a performance bonus.
To be sure, most expense increases at Fidelity---or in the industry--- aren't nearly as large. The trend, however, is rising expenses.
How broad is the pattern?
Very. Here's what I found in an examination of the largest equity funds at Fidelity and the largest equity funds in defined contribution plans.
• Eight of Fidelity's 10 largest equity funds increased expenses over the last three years; 19 of their 25 largest equity funds increased expenses over the last three years. (It should be pointed out that their expenses are still well below industry averages.)
• Industry-wide, 36 of the 49 largest equity funds used in defined contribution plans increased their fees. Only 13 decreased them.
Research from the Investment Company Institute appears to show the opposite--- that expenses are declining. Their research, however, includes both the ongoing expenses of the funds and their distribution costs. Fidelity cited this research in its March 12 statement before a Congressional subcommittee.
Unfortunately, the Fidelity statement omitted a major fact about the ICI data. When you strip away the distribution costs, which have declined due to the gigantic rise of 401(k) plans since 1980, the ICI research shows that equity fund expenses have risen. The delivery system costs less--- but the funds cost more.
Part of the current trend to higher costs, Mr. Vance explained in a recent interview, can be traced directly to the bear market. He pointed out that some fund expenses, like shareholder reporting and service, are relatively fixed. Other expenses, like asset management fees, tend to be reduced as assets under management rise. Together, both work to lower expenses in bull markets.
"…and they get taken back on the down side," he added, as expenses are spread over a smaller asset base.
For investors, when it rains, it pours.
Fidelity News Center
Fidelity Statement on Fees
Investment Company Institute
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