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Mutual Fund Returns Routinely Account for Management Fees

By Chet Currier
Bloomberg News
Sunday, March 6, 2005; Page F14

For sheer success in building a brand name, few financial firms can match the Vanguard Group.

In three decades of business, this mutual fund manager in Valley Forge, Pa., has created an empire of more than $800 billion in assets and 18 million shareholder accounts. Some of those investors are quite passionate about the subject.

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I hear from them frequently, singing the praises of Vanguard's low-cost style. And while they don't have to convert me -- I own shares of four Vanguard funds myself -- occasionally their fanaticism gets ahead of the facts.

Yes, true believers, low cost is an important attribute of a mutual fund. But no, low cost is not, and will never be, an end in itself.

Take a look at this e-mail from a reader in Tennessee about a recent column I did on the Janus Mercury Fund, which I mentioned had outpaced the Standard & Poor's 500-stock index during the 10-plus years I had owned it.

"I would like to know if the returns you cite reflect the fees paid to Janus for active management versus the fees I pay to Vanguard for passive management of my S&P 500 Index fund shares," my correspondent wrote. "I'm betting they don't, in which case a) you have misled your readers and b) your next column ought to be a correction of this one."

Wrong. That bet is a loser. Mutual fund returns such as the ones I cited for Janus Mercury routinely account for all common management fees and expense charges, which are collected from a fund's assets.

In the commotion over fund fees -- fanned over the years by Vanguard itself, numerous academics, financial journalists and New York Attorney General Eliot L. Spitzer, among others -- this basic fact has somehow been obscured. The result has been confusion that serves no investor very well.

Meanwhile, news snippets on fund fees just keep coming. The Wall Street Journal reported in February that the Securities and Exchange Commission is considering a move to require more prominent disclosure of funds' trading costs.

Do you know how much your fund pays in commissions every time it buys or sells? How good its trading desk is at finding the best available price, the most favorable bid-asked spread, day in and day out?

Juicy info, from the look of it. Yet what we stand to gain from knowing more about this may be less than it appears, especially if we don't keep it in context.

Commissions and spreads are already factored into the results that funds report every day via their net asset values per share. If the managers do a bad job at trading, it will detract from their performance. If they pay higher commissions than other fund managers do, they will realize smaller profits or bigger losses on the securities they sell.

That will hit them where it counts, by comparison with other funds they compete against. What assurance do we have that fund managers in general aren't neglecting the job of limiting trading costs? They are constantly measured against benchmark indexes as well as peer-group averages.

Those same fund managers must also compete against low-cost funds based on those indexes -- such as the Vanguard 500 Index Fund my correspondent is so proud to own.

Hedge-fund managers, take note. Hedge funds are at the infatuation stage of the product cycle, where mutual fund managers were about 20 years ago.

The time will come, experience tells us, when people will pay closer attention to typical hedge-fund management fees of 1 percent or 2 percent of assets per year, plus 20 percent of the profits.

Hedge-fund managers will know it is their turn on the political hot seat when critics really zero in on this, pointing out that fees at many a hedge fund make mutual funds look like a bargain.

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