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Viewpoint: Fund Industry's 'Fees Are Falling' Story Is Hard to Swallow

The latest industry study merely shows that investors increasingly are voting with their feet for lower-cost funds.

Once again, the

Investment Company Institute

, the trade group for the mutual fund industry, is trying to convince us that we're getting a doggone good deal when it comes to mutual fund investing. We know we're getting good returns -- thank the market gods for that. But are we really getting a good deal? I'm skeptical, and I'm not alone.

But the ICI says yes, and backs up its claims with an updated study of fund costs, out this month. According to the study, the cost of investing in mutual funds -- including sales and advertising costs as well as everyday operating expenses -- fell again last year, continuing a nearly two-decade decline. Equity fund costs fell 5.6% last year, to 1.35% of assets, on average, down from 1.43% in 1997.

Since 1980, equity fund costs are down by 40% while bond fund costs are down 29% and money-market fund costs are down 24%. What's more, contends the ICI, costs are down even if you exclude low-cost index and institutional funds, and those from the three largest (and low-cost) families --







So it appears that competitive forces are working to our benefit. But is the middleman really cutting us that much of a break?

Not surprisingly, soon-to-be-retired Vanguard Senior Chairman

John Bogle

(who will retain the title of industry curmudgeon indefinitely) scoffs at the ICI's claims. "I reject out-of-hand costs are going down," he emphatically says.

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For one, Bogle says a closer look at the numbers shows that costs for the least-expensive funds are on the rise, even while costs at the high end are coming down. "If the low-end guys are going up, where's the competition?" Bogle wonders.

Bogle adds that the ICI's analysis doesn't take into account the hidden cost of fund ownership, namely high portfolio turnover. In an industry where turnover rates approach 85%, the costs associated with all that trading -- including broker commissions and the impact on market prices of buying and selling -- amount to 0.5% to 1% a year for the average fund, Bogle contends.

But let's just gratefully accept, for the moment, the ICI's account of falling costs. Does the industry deserve all the credit?


senior analyst Scott Cooley doesn't think so. Fund buyers are simply choosing cheaper funds more often. "That isn't something the industry should be praised for. It's an investor-driven change," he says. What's more, investors who eschew broker-sold load funds to buy no-loads, but who pay an independent adviser for investment advice, may not be realizing any cost savings at all, Cooley says.

In any event, the debate about whether the industry at large is lowering costs over the long term, or whether the public at large has become choosier lately, is really irrelevant to the individual investor, Cooley says. "The one thing they can control is


fund. If their fund's assets are rising and expenses aren't falling -- that's a problem."

And there is no question that there are plenty of funds out there that just don't get it when it comes to cutting costs. Three years ago, I wrote that some pricey funds seem well worth the cost. I used the then-hot


Kaufmann fund as an example. Well, Kaufmann still has one of the highest expense ratios within its peer group -- except now its three-year return ranks it at the bottom of its category.

Kaufmann's not the only pricey fund with a questionable return, as the table below shows. Among funds with $250 million or more in assets, all are among the most expensive in their categories, but rank in the bottom third.

OK, so your fund's not one of the worst offenders. Does that mean you shouldn't fret about fund costs? When the market is doling out 15%-plus annual returns, on average, as it has for the past 15 years, I admit it's hard to grouse about a couple of basis points. But a sustained period of more "normal" returns would leave some high-cost investors feeling the pinch, as the table below shows.

So, don't get me wrong, I'm happy if investing costs are down by any measure, and by any amount. But I do wonder why we haven't seen more -- and more dramatic -- price cuts. Loads are way cheaper -- hooray! And yes, expenses for no-load funds dipped last year to 0.83% annually from 0.87%. But that's still up from 0.78% in 1980 -- in an industry where an exponential growth of assets has introduced the potential for enormous economies of scale, and competitors have virtually flooded the market.

Now, I'm no MBA. But I can't think of another business where customers have cheerfully paid more and more through the years, despite the fact that the more expensive the product gets, the worse it performs.

Anne Kates Smith is a senior editor at U.S. News & World Report in Washington. At time of publication, Smith had no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds.