Investors are preoccupied with sales fees, when they should really be looking at funds’ operating expenses. That’s the conclusion of a report by a team from the University of Michigan and the University of California at the Berkeley and Davis campuses.

"Purchase decisions of mutual fund investors are influenced by attention-grabbing information," said Lu Zheng, assistant professor of finance at the University of Michigan business school. "Investors are more sensitive to in-your-face fees and are more likely to buy funds that attract their attention through exceptional performance, marketing or advertising."

The researchers analyzed diversified U.S. equity mutual fund flows from 1970 to 1999 and brokerage data from 1991 to 1996.

They found that there was a consistent pattern of more money being invested in funds with lower sales loads and commissions. But funds with higher operating expenses experienced no decline in inflows and sometimes even saw an increase.

Mutual fund operating expenses – the percentage of assets spent on running the fund – are included in funds’ expense ratio. Expense ratios, which also include distribution costs, can range as high as 2% or 3%, seriously cutting into returns.

The public has moved away in dramatic fashion from mutual funds that entail front-end sales loads. The proportion of fund assets invested in load funds dropped from 91% in 1962 to 35% in 1999, according to the study.

But during that same period, operating expenses increased by more than 60%. These expenses dilute funds’ performance, but the effect is masked by volatility in the returns on equity mutual funds. That may explain why the researchers found no link between operating expenses and inflows.

The study’s results support the General Accounting Office’s recommendation that one step in educating the public about fund expenses would be for funds to disclose the actual dollar amount of fees investors pay, Zheng said.

"Expenses that remain out of sight are likely to remain out of mind," he said.

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