For investors who pay a high fee to mutual-fund managers, the obvious question is: Are the fees worth it?
The answer, unfortunately, is often no.
Data show that actively managed mutual funds with relatively high expense ratios—yearly fees as a percentage of assets under management—are associated with some of the worst performing and most poorly managed funds, especially in the U.S.-stock category.
In addition to poor performance, these high-fee funds are also associated with elevated levels of risk and excessive portfolio turnover. The high-fee U.S. large-cap mutual funds had average volatility (swings in price, calculated using monthly fund returns and expressed as a percentage) of 11.54% over the past two years, while the low-fee option came in at 10.23% over the same period. Equally troublesome is that the asset turnover at these high-fee funds is nearly double that of the low-fee funds. On average, high-fee funds sell or buy 67% of their assets under management in a given year, vs. 35% for their lower-fee peers. This is perhaps a sign that these managers attempt to trade more to justify the fee they charge, but from the investor’s point of view, this only leads to a higher tax bill due to short-term capital gains and an even lower posttax return.
Finally, according to Morningstar Stewardship ratings, high-fee funds are also more likely to be associated with poor governance practices—regulatory issues, poor managerial incentives and practices such as charging hidden fees (front-end fees, back-end fees, 12b-1 fees). Indeed, the more expensive funds have a 30% greater chance of receiving a failing governance rating from Morningstar than do their lower-fee peers.
Brokers won their fight against the controversial fiduciary rule. Now, a battle is brewing over a new proposal by securities regulators that would require them to cut back on sales incentives tied to customer advice.
The battle with the Securities and Exchange Commission will play out in 2019. Major brokerages including Morgan Stanley, Bank of America’s Merrill Lynch and Fidelity Investments are pressing the SEC to let them maintain current broker pay practices, arguing the plan could limit the products and services they provide.
SEC Chairman Jay Clayton, meanwhile, is staking his legacy on changes that would require more broker disclosures and limit sales incentives.
The proposal says that brokers should avoid “compensation incentives for employees to favor one type of product over another” and suggests pay for brokers be based on “neutral factors” such as the amount of time and complexity of the work involved. Brokers claim such a system could put their business model at risk.
.. The industry is hopeful Mr. Clayton’s statements mean the SEC won’t force brokers to eliminate all forms of variable compensation, but instead boost disclosure of pay arrangements and weed out some extreme practices such as sales contests.
.. Most brokerages pay their employees more for selling certain products over others, depending on how lucrative they are. This practice can result in customers paying more for products and services than they need to, though brokers defend the practice as the only way to reasonably offer a range of investment options. Without assurances their pay practices comply with government regulations, investment firms say they could stop offering certain products to avoid possible legal liability... To advocates of a tougher rule, pay incentives call into question whether a product is being presented to a customer for their benefit or for the broker’s.“Brokerage firms artificially create all sorts of perverse incentives to encourage brokers to make certain recommendations that are very profitable for the firm and the broker, even if they aren’t really good for the customer,” said Sen. Elizabeth Warren (D., Mass.) at the December hearing.
Mr. Baron’s mutual funds charge some of the higher investment fees around, and the fees have held steady despite a $1 trillion exodus out of old-school mutual funds into cheaper, better performing rivals that track a variety of indexes and investment styles.
In a global economy where competition and Amazonian price destruction have forced companies to cater to cost-wary customers, the mutual fund industry is a rare outlier. Fees on most actively managed mutual funds, which house the retirement savings and other assets of millions of Americans, have barely budged.
The reasons for that — quiescent mutual fund boards, complacent investors and a general unwillingness to call a halt to one of the great gravy trains in financial history — are all visible inside Mr. Baron’s fund family.
.. An old-fashioned stock picker, Mr. Baron achieved renown in the 1990s and the 2000s for successfully betting on small companies.
.. Mr. Baron, 74, is perhaps best known for his annual investment conference, now held at the Metropolitan Opera House at New York’s Lincoln Center and in its 26th year. Mixing rock stars, pop entertainment (Barbra Streisand and Paul McCartney have performed in the past), patriotism (this year celebrated the 100th anniversary of President John F. Kennedy’s birth) and triumphant chief executives, the gala is a giddy ode to American capitalism
.. Mr. Baron is unapologetic about the high fees. He argues that his skills and experience — and the arduous task of researching small growth companies — justify the fees.
.. “Since inception, 98 percent of our funds have beaten their benchmark,” he said in an interview. “If you want the lowest fee, you should not invest with us.”
.. But if you want to bet on American growth stocks, “you can double your money in 10 years,” he said. He frequently sticks with his top picks for decades.
.. Mr. Baron believes that the true measure of his success is performance since his fund’s launch in 1994.
.. Industry experts say there are several reasons that active mutual fund fees have not succumbed to broader pricing trends in the economy.
.. The first is their power. While more than $1 trillion has left higher-fee funds in favor of passive competitors, that still leaves some $10 trillion. That generates about $100 billion in fees for fund companies. And it suggests they don’t need to cut fees to retain assets.
.. With funds’ multiple share classes, varying structures and oceans of boilerplate, even sophisticated investors may not realize they are paying up for a laggard.
.. allege that trustees are not pushing hard enough for lower fees.
.. At the Baron fund family, the fee oversight is complicated by the fact that Mr. Baron, the largest shareholder in the investment company and the manager of its largest fund, has a financial incentive to keep fees high.
.. “Compensation based on fees is worrisome,”
.. “Kicking and scratching is unlikely to lower fees but certainly will antagonize the manager, which is the one institution that can arrange for the trustees’ dismissal. Besides, trustees will tell themselves, if a fund’s fees really are too high, the market will sort things out and investors simply won’t invest in the fund.”
.. In 1982, after a stint as a Wall Street analyst, he founded his investment firm.
His timing was perfect. It was the start of a bull market, and he developed an expertise in picking small companies that would grow into big ones such as Charles Schwab, Vail Management Company and Tesla.
.. It was the heyday of the individual stock picker. Peter Lynch at Fidelity and Bill Miller at Legg Mason gained cultlike followings
.. his annual investor gala, which he pays for himself, that defines him. Onstage, he cultivates a grandfatherly mien, bragging about how much money the chief executives of his portfolio companies made for Baron shareholders. His chief maxim is “We invest in people,” and he treats management as family.
.. he offered to connect her with his longtime tax lawyer. “It’s incredible what he has done,” Mr. Baron said