A Closer Look at the SEC’s Proposed Changes to Mutual Fund Fees
Over the coming months, mutual fund fees will come under greater scrutiny. Of course, there has already been a tremendous amount of attention devoted to fee structures, how the fund companies are compensated, how the adviser is compensated and so on. But what does this mean for the average investor whose financial planner suggests, say a dividend fund for them to invest in?
Well, there are several key areas that both regular and more serious investors need to be aware of when it comes to buying mutual funds. But first, let’s examine what the fee structure is all about.
For starters, the fees associated with mutual funds are called 12b-1 fees. This fee, at the moment, lumps all expenses into one, including what you pay to the fund company and ends up getting paid back to the adviser in the form of trailers. How much goes to whom is really anybody’s guess except for the fund company who manages collecting the fees and, in some cases, the adviser who might know what is being paid back to her.
Now, things get a little muddy when you consider that from the amount that the fund company gets to keep, how much of is compensation for the management team, how much is administrative and how much is sales and marketing. And, of those sales and marketing fees, how much gets paid back to the adviser responsible for successfully marketing that product?
The changes proposed by the SEC will eliminate a lof this confusion. To a large extent, this change is about as much of a shocker as disclosure of real estate fees might have been years ago. It makes sense to know what your adviser is earning, no? It also makes sense to know if Fund A that charges 0.90% and Fund B that charges the same thing are paying more toward management or more toward sales and marketing… which fund would you want, the one that underpays its management team or the one that pays them competitively? The implications are clear and, overall, these changes make for a more-level playing field for the industry.
Where the proposed mutual fund fee changes have a potentially greater impact is in how the fund companies can charge these fees. One of the changes recommend a maximum fee that the investor could pay. So while a 5.25% Front-End fee (the fee you pay to get into the fund) might charged on one class of fund for Mutual Fund Company C’s ABC Fund, the total Fund Company C can collect on all other classes class will also be 5.25% (or whatever the maximum is set at). So if your adviser suggests a no-load version of ABC Fund that charges just 0.9%, the most Fund Company C will earn is 5.25% (about 6 years worth of annual fees). Thereafter, the most they can charge for administrative-type fees will be 0.25%, good for the investor, not so good for the adviser.
Two Problems
The first problem with limiting fees is how will your adviser be compensated in those years after the maximum fee has been collected? Will this type of limitation encourage churning (where advisers recommend changes simply because of favorable fees — in this case, no fee vs. fee is heavily tilted on the fee side)? We argue that it will. And if fees are not paid by the fund company, then it is likely that advisers will start charging management fees… but at what cost? Will the average Joe be able to afford the advice and services of a decent adviser (today, trailer fees allow a relatively average investor to obtain fairly decent advice).
The second problem is how will fund companies change in terms of quality and sustainability? If fees are only to be collected to a maximum of x%, is it in the in anyone’s best interests to encourage buy and sell investing? And what will happen to funds that people traditionally bought and held for decades?
More Work Needed
Without question, added transparency is always a good thing. It often keeps key individuals and companies honest and allows for a more-level playing field. But will the changes to 12b-1 fees that the SEC is proposing actually limit competition and close the door on a segment of the investing public that needs access to good advice as well as the best-managed funds?
At the Mutual Fund Site, we believe more work is needed before such huge changes are put into force. As they stand, they could serious impact the quality of service individual investors receive at the fund company as well as adviser level and, in some cases, will probably result in a lack of access to a segment that needs it the most.
