Mutual Fund Fees, Politicians, Lawyers And The Scorekeepers

What gives you bargains in portfolio management—lawsuits or competition?

Some of the fees collected by money managers are outrageous. Investors need protection. Who will guard us against the wolves of Wall Street?

Saviors fall into three categories: politicians, lawyers and what I will call scorekeepers. I will consider the contributions of each. The second group just got a big win in the Supreme Court: an 8-0 decision in the case of Hughes v. Northwestern University.

I am not applauding what the high court did. I prefer the last category of defenders, although you may discount my reasoning because I have an ax to grind.

1 Politicians

We could have the government protect consumers from high prices by decree. The emperor Diocletian had price edicts. The U.S. had price controls during the Second World War and again under President Nixon. Until a few decades ago, air fares and freight rates were under the supervision of bureaucrats.

Hugo Chavez protected Venezuelans from grocery prices. In New York, price regulation dictates apartment rents. Elizabeth Warren would, if she had the power, do the same to the pricing of all financial services.

Do I like this approach? Only when it suits my interests. I live in an area served by one Internet provider, and I would much appreciate a state law cracking down on its rates. But most of the time, in most places, price controls do not enhance citizens’ well-being.

There’s an important difference between Internet service and the mutual fund business. The former is often a monopoly. The latter is not. There are 6,900 funds competing for your dollars.

2 Lawyers

The Investment Company Act of 1940 sets up an elaborate mechanism for keeping fees on mutual funds in line. Each fund must have an “independent” board that bargains with the company selling the fund. In a similar vein, the Employee Retirement Income Security Act of 1974 imposes a fiduciary obligation on employers to get good deals on the funds in their pension plans.

And so it is that litigation over the fairness of fees pays for many a yacht. The Northwestern case has to do with whether the university breached its fiduciary duty by including overpriced funds on its retirement plan menu alongside fairly priced ones. Monday’s unanimous decision allows the litigation to proceed.

Some academics favor lawsuits as a way of keeping fees low. For Stewart L. Brown of Florida State University this has become an idée fixe. (Here’s one of his papers.)

But consumers do pretty well without platonic guardians. You don’t get to elect some fiduciary board to determine the price of eggs at Wal-Mart. If you don’t like the price, you shop across the street.

Those supposedly independent boards setting fund fees have turned into rubber stamps. But they aren’t costless. Nor are the court cases. The prices of financial services end up as the sum of two numbers: whatever they would be in the absence of fiduciary litigation plus whatever it takes to pay off the lawyers. Congress could save money for investors by ending the independent-board farce. Repealing most of Erisa would also be helpful.

3 Scorekeepers

This category includes Morningstar, which allows you to screen for cheap funds, and, ahem, Forbes Media. Forbes has been calling attention to fund expenses for half a century. My most recent Reader Asks column opines that you should be leery of any fund that costs more than 0.1% of assets annually; I frequently publish Best Buy rankings of mutual and exchange-traded funds, such as the one in this Guide To International Investing.

The scorekeeper harping about costs, and the marketing skills of Vanguard founder John Bogle, have combined to make price wars a prominent feature of the money management business. Indeed, Fidelity now has index funds with 0% fees. Politicians didn’t do that for you, and neither did the lawyers.