In the wake of a massive settlement that forced Alliance Capital to lower mutual fund fees, an increasing number of fund shops, most notably MFS Investments, are cutting back operating expenses charged to shareholders.
At first glance, the changes to the fee structures at these firms appear to be attributable to the wave of new assets coming in the door, a trend fueled by a strong rally in the stock market. Indeed, flows have been strong as evidenced by the roughly $33.5 billion U.S. diversified equity funds took in through November 2003, according to New York fund research firm Lipper.
But considering the fact that mutual funds rarely lower their fees, the timing of these revisions certainly warrants a closer look. In December, New York Attorney General Eliot Spitzer reached a settlement with Alliance following an investigation of improper trading practices at the New York-based fund manager. In addition to a $250 million fine, the company agreed to reduce management fees by 20% over the next five years, a move that would save investors up to $350 million.
Spitzer has demanded that lower fees be part of any settlement with regulators and promised he will continue to go after funds to negotiate fees at "arm's length." The Alliance settlement drew widespread criticism from industry officials who believe that Spitzer overstepped his bounds. The Investment Company Institute argues that prices should be determined by the marketplace and not by the government, state or otherwise. Since the settlement, the two sides have exchanged blows in what has become an ongoing spat over fees.
In recent filings with the Securities and Exchange Commission, at least half a dozen funds said they are lowering the limit on operating expenses. As the number of assets in a fund swells, administrative costs including transfer agency, custodian and legal fees tend to shrink as a percentage of net assets. The end result is a lower expense ratio for the fund.
Smart' Move
MFS of Boston is the most prominent firm revising its fees structure. In a series of filings entitled "supplement to current prospectus", the company lowered management fees on the $6 billion MFS International Equity Fund and the $5 billion MFS Global Equity Fund from 100 basis points to 90 basis points. In addition, MFS cut the 12b-1 fees on nine of its international funds, including the MFS International Growth Fund and MFS International Value Fund. While the maximum sales charge for Class A shares will be increased to 5.75%, the 12b-1 fees will be reduced to 0.35%, according to the filing.
"They're very smart for doing this," said Max Rottersman, president and founder of FundExpenses.com, a New York research firm that analyzes fund costs for institutional clients. "International funds are getting hotter and MFS figures they can get a two for one deal - lowering fees to look good and make it easier for people to invest in their funds."
MFS, a division of Toronto-based Sun Life Financial, has the dubious distinction of being one of the firms under investigation for engaging in improper trading practices. Regulators are reviewing whether representatives for MFS advised certain investors about how to make rapid short-term trades in its funds. MFS pledged in its prospectuses that it would deter such market timing activities, a fact that puts them on the hook for it.
While recent reports have speculated the company is nearing a settlement with Spitzer's office, MFS denied any connection between the fee cuts and the issues regulators are targeting. "We've had no discussions [with regulators] about lowering fees on our international funds," said David Oliveri, an MFS spokesman. He said that asset growth was the "single determinant" in lowering management fees on the two funds. International Equity grew to $6 billion from $1.6 billion in the two-year period extending from September 2001 to September 2003, while Global Equity rose to $5 billion from $2.7 billion during that time frame.
Also contained within those filings were new exchange policies that would more effectively curb market timing in MFS funds. The company said it will exercise its right to restrict, reject or cancel purchase and exchange orders from investors who make three exchanges of $10,000 or more in any of its international or fixed-income funds and six exchanges of $10,000 or more in any other MFS fund. In December, the company implemented a 2% early redemption fee on all its international and global funds for in-and-out trades that occur within 30 days of each other.
Economies of Scale
Another fund lowering its fees is the $185 million Al Frank Fund. In its filing to the SEC, Al Frank said its investment advisor, Al Frank Asset Management agreed to lower the fund's annual operating expense limit to 1.98%, from 2.25% effective Jan. 1. Portfolio manager John Buckingham said that the logic behind the move was that expenses were not running at 2.25%, but rather for six months of the year they were closer to 2%. Even with the cap at 1.98%, a decision it made several months ago, the fund's current expenses are around 1.8% due to an influx of new money.
Assets under management grew to $185 million from $47 million last year at this time and the fund posted a 78% gain through November, according to Morningstar. That growth spurt allowed for the economies of scale to kick in to the point where the company felt it was sufficient enough to lower the expense ratio.
"Eliot Spitzer or no Eliot Spitzer, we were going to do what is right, which is having our shareholders pay what the actual expenses are," Buckingham said. With respect to market timing, the Al Frank Fund instituted in March 2002 a mandatory 2% redemption fee on all exchanges up to 60 days from purchase, well before the scandal broke. "If you don't want to commit to up to 60 days, then we don't want you," he said.
Given the current regulatory environment, he acknowledged that lower fees present an excellent marketing opportunity for the fund. Still, some industry critics may argue that 1.8% is still too high. "You get what you pay for. If we triple your money in six years when the market has gone nowhere, we think we've earned our fee," he said.
The $117 million Chase Growth Fund cut its annual operating expenses to take advantage of economies of scale, lowering the cap to 1.39% of the fund's assets from 1.48%. And the $30 million Baird Mid-Cap Fund took an axe to its fees as well, citing similar motives.
"We are always reviewing our fees from a competitive standpoint and in the context of assets under management to provide our customers with a favorable cost structure," a spokesperson from Baird Funds said.
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