Magazine article The CPA Journal

The Predictable Aspect of Mutual Funds: Fees

Magazine article The CPA Journal

The Predictable Aspect of Mutual Funds: Fees

Article excerpt

The increasingly competitive mutual fund marketplace has spawned a host of pricing alternatives and fees that can confuse even those who are most familiar with mutual funds. Mutual funds are highly regulated and disclosure of all fees is required. But they may often seem buried in legalese. Here are some basics to look for in mutual fund expenses, pricing, and other fees.

EXPENSES--THE PROSPECTUS AND STATEMENT OF ADDITIONAL INFORMATION

The prospectus and the statement of additional information (SAI) both offer detailed information on fund expenses. The SAI, unlike the prospectus, is not required to be delivered to prospective shareholders except upon request. But it contains a wealth of further information. Request it when you order a prospectus; use the table of contents in both.

The prospectus begins with mandated fee tables. Within the first few pages are fund expenses for the most recent fiscal year broken out into management fees, distribution expenses (sometimes called 12b-1 fees, service fees, or asset based sales charges), and "other" expenses. These annually recurring fund expenses make up the expense ratio. Also in the first few pages of the prospectus are 10 years of condensed financial information, including the expense ratio for each year. The expense ratio is the total of all these fund expenses divided by the average net assets (size of the fund) during the fiscal year.

The statement of operations at the end of the SAI gives a fuller picture of the "other expense" component. Check the directors' fees, for instance. They should not be excessive relative to can-charge management fees; sales charges are just a way to get professionals to help sell the funds. In 1993, the National Association of Securities Dealers (NASD) leveled the playing field among funds with sales charges by adopting rules that limit sales charges as a percentage of new sales plus projected appreciation of a fund's prior assets. These rules are based on the total of front-end, back-end, and asset-based sales charges and take into account whether a service fee is charged.

The regulatory agencies have also attempted to give potential investors a clearer idea of what their charges will be by requiring a table that hypothetically estimates the dollar cost of all charges for all classes, including sales charges and fund expenses, with (and sometimes without) redemption, for a $1,000 investment earning a five percent hypothetical annual return over different time periods. These tables appear early in the prospectus and allow a reader to estimate the differences between classes without a compounding calculator. But they don't take into account variations in performance.

RULE 12b-1 fees

The Investment Company Act of 1940's Rule 12b-1 established these fees to allow distributors to compensate broker/dealers for selling their funds. Often, a small fee, usually about .25% annually, is funnelled through broker/dealers and a portion paid to the registered representative who sold the fund for as long as the shares are in the fund. In effect, the fee gives the registered representative or financial advisor a kind of "annuity" for the assets the fund company retains. It encourages the representative not to move a client out of the fund, and the funds management firm derives income from the client's investment. For older funds that did not always have these fees, the total 12b-1 percentage actually charged to the fund may not be as high as the maximum allowed because not all the assets of the fund are subject to it.

True "no-load" funds will not have sales charges or 12b-1 fees. The management fee and "other" expenses will make up the total. But some "direct-marketed" funds that look like no-loads, because there are no front-or back-end sales charges to the investor, do have 12b-1 fees in order to offer incentives to brokers.

In the case of some newer classes of shares, B and C shares, an extra fee, sometimes called an asset-based sales charge, usually about . …

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