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Advice on mutual fund fees is questionable

GAO implies fund advisers are not telling whole truth

SHARE Advice on mutual fund fees is questionable

Listen up, mutual fund investors, the authorities are running out of patience with you.

You're not paying enough attention to the fees that funds collect from your invested money each year, despite repeated efforts to raise your consciousness on this subject. As a result, the goal of perfect competition is not being achieved.

The General Accounting Office, the investigative arm of Congress, doesn't blame you explicitly. It says the main fault lies with the people who market funds, and the problem may be remedied by requiring them to disclose more information to you.

Even so, the agency strongly implies that you're not looking out for your own best interests as well as you might. Consider these words from the executive summary of the GAO's report this month urging that funds be required to disclose dollar amounts of expenses in investors' quarterly account statements:

"Although hundreds of fund advisers compete actively for investor dollars, their competition is not primarily focused on the fees funds charge. Instead, mutual fund advisers generally seek to differentiate themselves by promoting their funds' performance returns and services provided.

"Marketing their performance and service as different from those offered by others allows fund advisers to avoid competing primarily on the basis of price."

Now there's a blast at active fund managers worthy of the most militant efficient-marketeer. Performance results published by funds, it says right there, are camouflage to hide the fact that funds are basically a fungible commodity, like oil or orange juice.

I wasn't aware that the question of the value of active fund management, which has been debated for the last 30 years, had been settled so definitively. Many fund managers insist to this day that they add value, lots of value, in performance and customer service — that each fund is different in, among other things, the degree of risk it takes.

But that's not the main issue we're discussing here. The subject on the table is why investors willingly buy stock funds charging annual expenses of about 1.5 percent of assets, on average, when they could choose perfectly good funds from low-cost firms like the Vanguard Group and TIAA-CREF Corp. with expense ratios of 0.5 percent or less.

That's a difference of 1 percent a year, which can add up to real money over time.

Nobody knows the full answer. Any attempt to understand the situation, though, must start with the fact that the results fund investors see and get are always after fees. Price competition is there all right — it's factored into performance, about which investors have shown they care passionately.

A fund that earns a raw return of 25 percent and charges 2 percent in expenses produces a net return of 23 percent. Another fund that earns a raw return of 23 percent and charges 1 percent has a net return of 22 percent. The second fund is twice as cheap as the first one, but is that cause to prefer it?

Of course, performance can and will fluctuate, while the fees will likely remain the same. On balance, studies have shown low-expense funds tend to post better bottom-line results than higher-expense funds. So it's easy to buy into the GAO report's wish to see fees isolated for inspection even more than they already are (at the front of fund prospectuses and elsewhere).

But it's a little high-handed to suggest that investors can't see the point now. They're clearly able to prefer, say, a money market fund yielding 6 percent over a bank money market deposit account yielding 4 percent, as per the latest report from Bankrate.com (the GAO report's suggestion, by the way, of banks and brokers as models of fee disclosure by comparison to funds is ridiculous).

As long as Vanguard's, TIAA-CREF's and other low-fee funds are readily available, price competition in funds is a fait accompli. To take an analogy from a different business, the fact that Neiman-Marcus won't match Wal-Mart's prices does not mean the consumer is getting a bad deal.

Similarly, if investors think they get their money's worth from, say, the Alliance Premier Growth Fund, with an expense ratio of 2.2 percent according to Morningstar Inc., who am I or anybody else to tell them they're mistaken? Over the last five years the fund's Class B shares—after expenses, remember—have returned 29.8 percent a year, beating the Standard & Poor's 500 Index by more than 6 percentage points.

For myself, I'd never buy a fund with such a high expense ratio. But I also have to tell you that most of the lower-cost funds I've picked haven't achieved results that good.

So competition in the market for mutual funds is demonstrably imperfect. It's a big leap from that, though, to say we can fix the imperfections if we just create the right regulations.

Better to heed an old rule of retailing: No matter what you think about what the customer is thinking, the customer is always right.