High Fees Seen as Driving Investors Away from Funds

Fund firms have earned more in fees than investors have gained from the funds themselves in recent years, and investors may choose to invest, instead, in low-fee, exchange-traded funds as an alternative, according to a recent report by FundExpenses.com.

"The benefits that funds used to offer are no longer valid," said Max Rottersman, author of the report, adding that investors can achieve diversification via exchange-traded funds. He also noted that investing in individual stocks may become more appealing since brokerage fees have dropped from several hundred dollars to well below $100 at some discount brokerages.

Further supporting his theory of the increased indifference to the fund industry, the report showed a mere $14 billion in net new sales throughout the whole of 2001. Last year, equity mutual funds lost $10 billion, although due to a record $130 billion into bond funds, mutual funds of all types wound up with a net $72 billion (see MFMN 1/21/03).

After 1997, investors who sent $640 billion into equity funds made 4.5% on their money, or $29 billion, at best. Meanwhile, the funds earned $90 billion in that period from all assets managed. While the equity markets are still slumping, equity funds have taken in $47 billion in advisory fees from September 2000 through November 2002.

The report argues that while advisors pocketed a lot of money in high-bulk market assets, 40 basis points may not seem like a lot during a bull market, but it is magnified against investors’ asset losses during this prolonged bear market. Additionally, the report notes that funds earned $60 billion in advisory fees from 1998 to the end of 2002, while new investors pumped $303 billion in and actually lost money.

Investors in equity funds have not realized a return on their investment in five years of professional money management, according to the study. Since the beginning of 1998, the industry, which had $2.5 trillion in equity funds at the time, has taken in about $90 billion in advisory fees and has had $190 billion in total expenses. This translates into a 1.2% expense ratio, which means that, if an investor bought an equity fund at the end of 1997 and that fund had a negative return, the investor also suffered a 6% loss from the fund expenses alone.

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