Management Fees Rise With Industry Demand

U.S. mutual fund companies are charging much higher management fees than they did when the industry was in its infancy in the 1920s.

The minimum management fee for funds opened in the 1920s was $3.80 per $1,000 invested, said Don Phillips, president of Morningstar Inc., a fund industry research group. That rose to $5.30 per $1,000 invested in the 1950s, when the industry was still a pipsqueak.

Today, management fees are almost double what they were in the 1920s and are up 35% from the 1950s. Funds introduced over the last decade are charging a minimum management fee of $7.20 per $1,000 invested, Phillips said.

Until the last decade, mutual funds weren’t the investment of choice for most Americans, which meant fund companies didn’t compete as vigorously for potential clients. At the same time, fund companies didn’t have to compete vigorously for top-flight fund managers, pay the salaries they now command and buy the latest technologies they use to run their clients’ money.

“There was very little demand for mutual funds until the mid-1980s,” said Robert Stovall, president of Stovall/Twenty-First Advisers Inc., a New York-based money management firm. “Now investors are buying funds like they buy Coca-Cola.”

Fund companies have always made money based on the assets they manage. Today they oversee about four times more in customer assets than they did at the start of the decade; industry assets now total about $3.7 trillion. Even as recently as 1979, the entire mutual fund industry had only $95 billion in assets, less than today’s assets for Fidelity Investments’ three biggest funds.

Some fund executives have defended the increase in management fees by saying investors themselves set market prices and it’s wrong to insinuate that the industry is bilking them.

Shareholders are certainly part of the reason why management fees are as high as they are, Phillips said. “If they hadn’t grown so complacent, the industry could never have given itself such a phenomenal pay raise,” he said.

Still, fund companies should be better at keeping down fees, Phillips said. “You can run a thrifty outfit or a lavish one,” he said.

The money management business is a textbook case of an industry that has tremendous operating leverage, Phillips said. That’s especially true today because portfolio managers can access huge databases of information with a few computer keystrokes, travel the world in days rather than weeks and make trades automatically rather than writing them out by hand.

It isn’t a capital-intensive business, even with all the computer technology that fund managers use, so once assets reach a certain size, each additional dollar that comes in the door can be managed at little added cost, Phillips said.

But rather than passing along the economies of scale, the industry is taking a bigger cut, Phillips said.

The venerable Massachusetts Investors Trust, which started in 1924, still charges a management fee of only $2.30 per $1,000 invested. But when Investors Trust’s management company, Boston-based MFS Investment Management, introduced the MFS Research Fund 47 years later, it adopted a more up-to-date fee structure. Today this fund levies a management fee of $4.10 per $1,000 invested.

Massachusetts Investors Trust has assets of $4 billion and has a better record than MFS Research Fund, which has assets of about $3 billion. Investors Trust has returned 20.03% this year, 35.85% over the last 12 months and an average of 27.05% per year over the last three years, compared with the Research Fund’s returns of 13.39%, 22.77% and 25.2% for the respective periods.

It’s hard to see how the MFS Research Fund will ever be as cost-effective as the older fund, Phillips said.

The management fee tends to be the largest part of the fund expenses that investors must cover. Other fees are charged to offset marketing, trading and administrative costs.

The average domestic stock fund has total fees, including for management, that equal $14 per $1,000 invested, Morningstar reported. That’s 1.4%.

There are some reasons for the higher fees, according to the Investment Company Institute, the mutual funds’ trade organization. It costs more to run some of the newer funds, such as those investing in small companies or in foreign stock markets, than it ever did to run a “plain vanilla” fund investing in larger U.S. companies, the ICI reported.

What’s more, the proliferation of new funds taking advantage of the boom tends to push up the industry’s average management fee. Funds have a scale of management fees dictating that as assets managed grow, the fee declines. Newer, smaller funds, then, charge the highest fees.

Today, there are more than 6,500 funds, up from 500 in 1978, according to the ICI.