Morningstar has taken issue with the Investment Company Institute's recent report on declining bond, money market and equity mutual fund fees (MFMN, February 22), calling ICI's comparisons faulty on a number of fronts.
The Morninstar critique came in a white paper, "Revisiting Fund Costs: Up or Down?" written by Scott Cooley, a Morningstar analyst, and issued Feb. 19.
Morningstar objected to ICI's including both institutional and actively-managed retail funds in calculating fees. Actively-managed funds clearly cost more to run, said Morningstar. It is also misleading to lump together domestic and foreign funds because foreign funds also cost more, Morningstar said. Morninstar also questioned ICI's lack of differentiation between load and no-load funds.
To make a "cleaner comparison," Morningstar evaluated load and no-load funds separately, and randomly selected 15 families, Cooley said. Further, he eliminated their index and institutional shares.
"And we looked at the data both with and without the low-cost giants, i.e. Vanguard, Fidelity and American Funds ... to see if only a few shareholder-friendly families had skewed the numbers in the industry's favor," Cooley wrote.
Cooley agreed, however, with ICI's definition of total ownership costs- the expense ratio plus a pro-rated share of a typical investor's load, since investors tend to hold their funds for several years. Neither Morningstar nor ICI looked at trends in management fees and 12b-1 distribution and marketing fees.
Looking at total ownership costs alone, Morningstar found that the cost of no-load funds decreased 10 percent from 1984 to 1998, from 80 basis points to 73. Cooley called this a "modest" reduction by an industry whose assets have risen "so dramatically over the past 14 years."
ICI had reported that the cost of investing in equity mutual funds between 1980 and 1997 had decreased 33 percent, the cost of bond mutual funds dropped 25 percent during this period, and the cost of money market funds fell 15 percent.
Total ownership costs for load funds fell by about 25 percent between 1984 and 1998, Morningstar found. Cooley said that only American Funds have a noteworthy performance in passing economies of scale down to investors. This skewed the load fund figure considerably, Cooley says. If American Funds' load funds are excluded from the group, load fund fees decline only 15 percent.
"While fund families like Vanguard and American Funds deserve a standing ovation for their shareholder-friendly expense reductions, much of the industry doesn't even merit a round of faint applause," Cooley said. "Savvy investors have sought out low-cost fund organizations, [and] while that makes asset-weighted total-cost ratios decline, it does not necessarily signify that funds' directors are going to bat for their shareholders."