Raiding the Returns

Although fallout from the mutual-fund trading scandals still dominates the headlines, some companies with 401(k) plans reserve their greatest ire for another issue: fees.

Complaints focus mainly on the steep fund expenses that are passed on to plan participants — an average of 156 basis points for administration, plus commissions and other transaction costs — and on how hard it is to determine what individual charges the fees include. Both those concerns reflect what plan sponsors say is an historic culture of unresponsiveness among funds to fee-related questions. (Transaction costs are not included in normal shareholder reporting.)

"It's pretty appalling," says Jim Price, a Tatum Partners CFO who works for Client Dynamics Inc. He says he has been "told by some providers that the fees would be buried so that none of the participants would ever notice." That's not something he wanted to hear, since he was trying to reduce the cost exposure for the company's 15 employees. After vainly "looking through the fine print" for details of specific charges at various plans, he eventually decided on a Smith Barney­administered plan with high returns and a fee structure that was lower and more transparent than competitors'.

Indeed, more than 90 percent of finance executives in CFO magazine's recent mutual-fund survey thought fees were too high, with more than 70 percent saying they were quite concerned about fee levels — a greater percent even than expressed worries over unethical trading practices.

"If you've stayed with one provider for 10 years, that provider doesn't think it's part of the job to explain the fees," says Bruce A. Jackson, CFO of Cedar Fair LP, an amusement-park operator in Sandusky, Ohio. Until recently, he thought high fees were an unavoidable cost of fund investment for the 600 participants in the company's plan. Then, with the help of one of the growing number of consultants now specializing in fee negotiations, Jackson says he found that "mutual-fund providers are offering a lot of concessions to get money into their fund groups." By identifying specific components of that fee structure, he adds, "we were able to get a number of discounts."

Even without negotiations, though, some plan sponsors are beginning to see lower fees. Several funds have reduced fees in the months since the trading abuses began surfacing, and have taken other steps to boost pricing transparency. In some cases, fee reductions have been included as penalties in the settlement terms imposed by regulators. (The Securities and Exchange Commission and the Department of Labor are both reviewing mutual-fund fee structures, but so far both have focused more on trading issues.) Still other funds have made voluntary fee cuts part of a new strategy.

A Blessing in Disguise
Some critics suggest that general market forces — and the tendency for more customers to shun high-cost funds — are responsible for much of the cutting. Those critics add that cuts so far are barely touching the excessive costs that prevail among nearly all funds.

"I think it's a blessing in disguise that the trading abuses have come to light, because they have caused us to take a look at the whole industry," says Sen. Peter G. Fitzgerald (R­Ill.), co-sponsor of the broad Mutual Fund Reform Act of 2004 (MFRA), which seeks to prevent future trading abuses while also improving fee disclosures. Compared to the problem of high fees, "the trading abuses can be addressed relatively easily," he says. And trading improprieties "are far less costly to mutual-fund shareholders." Spread over the decades-long life of a plan, he notes, a few excess basis points can cost retirees tens of thousands of dollars.

The senator, a former commercial-banking attorney who now heads the Subcommittee on Consumer Affairs and Product Safety, believes Congress is partly at fault for lax scrutiny of the mutual-fund phenomenon. After all, the industry got its biggest boost when government-created, tax-deferred investment vehicles, including retirement plans, fueled the rapid growth of the mutual-fund industry. "Mutual funds have grown from $115 billion to a $7.4 trillion industry in 24 years," he says, while regulators "weren't paying as much attention as they should have been," and funds "had almost a guaranteed market."

Over that long haul, mutual funds have not been the star performers they often claim to be, according to testimony before Fitzgerald's subcommittee. "Eighty-eight percent of mutual funds underperform the market over time," says the senator, with funds returning only 9 percent on average over the past 20 years, compared with 12 percent for the market in general. "The difference between the 12 percent and the mutual funds' 9 percent," he says, "is the fees."

Beyond the costs represented in the standard expense ratio that funds now disclose, says Fitzgerald, transaction costs often add another 75 to 150 basis points. The MFRA seeks to require transaction-cost disclosure in order to give investors more guidance in deciding which funds to buy, among other benefits. The hidden transaction charges, reflecting commissions and spreads on trades, for example, "are a very real cost, and they eat into investment returns just like any other cost."

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