Internet Cost Savings Have Yet to Reach Mutual Fund Industry

Low-cost 'e-shares' are, for the most part, still a dream.
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It has happened for everything from books to banks. But in the mutual fund industry, the Internet has not produced any obvious discounts for the consumer.

Unlike other financial services sectors, mutual fund firms haven't aggressively harnessed the Net to save investors money. The brokerage industry has seen stock trading commissions in the Internet era tumble from hundreds of dollars to less than $10 in some cases. Some online-only banks are offering cheaper checking accounts and higher interest rates than their offline competitors.

But while mutual fund firms use the Net to communicate with investors, few, if any, can show proof that costs are coming down because of it. No major mutual fund companies offer a price break to customers willing to forego expensive mailings and toll-free phone numbers and conduct transactions entirely online.

The only thing resembling an online discount comes from

E*Trade

(EGRP)

-- a brokerage -- which this week announced it is expanding its line of online-only index funds from one to four. In a release, E*Trade calls one of its new funds, the

E*Trade Technology Index

, "the first low-expense-ratio, no-load product in the technology space." But a comparison of expense ratios shows the savings are nothing to write home about.

E*Trade's Technology Index has an annual expense ratio of 0.85%. That's lower than the 1.25% levied by the

internet.com Index

fund offered by

Investec Guinness Flight

, but significantly higher than the 0.35% charged by the

recently launched

Unified Select Internet

fund. It's also higher than the average 0.59% average expense ratio for domestic index funds calculated by

Morningstar

.

E*Trade did not respond to requests for an interview regarding its funds.

"I don't see a real stampede on the part of mutual funds to use the Internet to cut costs and therefore provide higher returns to investors," says Jim Marks, a financial services technology analyst with

Deutsche Banc Alex. Brown

. "What they're interested in more is using the Internet as a marketing tool."

If the brokerage industry is any indication, price competition in the mutual fund industry will have to come from an Internet-based upstart. That upstart could be

StockJungle.com

, a Culver City, Calif.-based money-management firm that's planning to launch the

StockJungle.com Free S&P 500

fund with an annual expense ratio of zero.

"One of the slowest adopters

of the Internet has been the asset management industry," says StockJungle.com's 27-year-old chief executive Mike Witz. To keep costs down, Witz says investors must agree to receive all communications -- including account statements, prospectuses and annual reports -- electronically. (E*Trade has the same requirement for its funds.)

StockJungle's prospectus for its funds suggests how those steps may help the company keep costs down. StockJungle.com will charge a 1% annual management fee for its three other funds, including its

Pure Play Internet

fund. The funds will not levy sales charges or 12b-1, transfer agent or administrative fees; these costs will come out of the management fee. StockJungle plans to begin selling its funds in October.

Witz, a former senior analyst at

Financial Resources Group

in Marina Del Rey, Calif., says he started StockJungle.com because the mutual fund industry wasn't aggressively using the Internet to cut costs. "There's a general attitude of 'We've got a good thing going here, let's not go and try to break it,'" he says.

Of course, the fund industry is not blind to the changes going on around it. Some major fund companies such as

Vanguard

and

Fidelity

use the Internet to distribute fund materials electronically to customers who request it.

At Vanguard, 37% of the firm's interactions with its clients are conducted over the Internet, says Shelton Unger, director of online services. Yet only 5% of Vanguard's 13 million customers have chosen not to have their statements mailed to them. Fidelity says 29% of its fund trades, including those made through its own brokerage arm, are done online, vs. 14% at the end of 1998.

There has been talk in the industry of offering "e-shares" of funds, which would have lower expense ratios for investors who agree to communicate only electronically. But Unger says Vanguard doesn't plan on offering e-shares because it doesn't want to limit the ways in which its customers can interact.

"We want to remain connected with our clients over the phone, through the mail, however, so we can answer their questions," says Unger. "We don't want to limit them in any way to the Internet."

One industry consultant says fund investors will realize cost savings from the Internet, but they will come from the less-visible administrative end of the business.

"There is a savings, there's no question. But the real savings really flow to the firms like

Charles Schwab

(SCH)

and Fidelity, not as advisors to the mutual funds, but more as processors, if they're able to reduce the human intervention and arguably the error factor," says Geoff Bobroff, a consultant in East Greenwich, R.I.

To be fair, the dramatic cut in commissions that stock investors witnessed in the past few years came to the mutual fund industry years ago through the introduction of no-load funds.

Still, funds sold through brokers remain a large part of the industry. And Philadelphia fund consultant Burt Greenwald says one reason the industry is slow to embrace the Internet is a fear of upsetting brokers.

"The fund industry . . . is not about, at this point, to set up two classes of shares for those people who go direct," Greenwald says. "It would destroy their dealers, and they've got to preserve the integrity of their intermediary distribution system."

But he sees that allegiance fading quickly, especially since leading brokerage firm

Merrill Lynch

(MER)

shook up the industry earlier this year by announcing plans to compete aggressively online.

"I would say within two or three years of

Merrill coming online, the upfront sales charge on most mutual funds will disappear," Greenwald says.

Even so, Greenwald says the mutual fund industry will continue to focus on the Internet as a tool of convenience, not as a cost-cutter.

But in the stodgy world of mutual funds, the most "convenient" thing to do is usually nothing. Which is why your prospectus is still probably in the mail.