Mutual fund buyers forget to check fees

Out of sight, out of mind: At least that seems to be the case when it comes to mutual fund investors and their costs of investing.

Mutual fund buyers seem to have become very educated about visible sales commissions in recent years. However, they still don’t seem to pay attention to high, but hidden, operating expenses, a trio of finance professors claims in a new study of mutual fund expenses. “Purchase decisions of mutual fund investors are influenced by salient, attention-grabbing information,” said Lu Zheng, assistant finance professor at the University of Michigan in Ann Arbor. “Investors are more sensitive to in-your-face fees and are more likely to buy funds that attract their attention through exceptional performance, marketing or advertising,” she added.

Lu Zheng conducted a study with Brad Barber and Terrance Odean of the University of California that analyzed flows of money into and out of mutual funds from 1970 through 1999. They found that the portion of mutual fund assets invested in load funds—those that charge visible commissions when purchases are made—declined from 91% in the 1960s to just 35% in 1999. Over time they found a significant negative association between up-front load fees and commissions and mutual fund purchases.

However, they found a positive association between funds with high internal operating expenses and fund purchases, indicating that investors were buying funds without analyzing operating costs. “While operating expenses constitute a steady drain on a fund’s performance, the effect of that drain is masked by the considerable volatility in the returns on equity mutual funds,” the trio said. Internal expenses on some funds can range as high as 3%, which greatly reduces the net return flowing to investors. Average operating expenses increased 60% during the period covered by the study.

Recently, the General Accounting Office proposed that mutual funds make better disclosure to investors about the actual dollar amount of fees paid in operating expenses. Professor Zheng said the results of the study indicated that new disclosures are necessary. Otherwise “expenses that remain out of sight are likely to remain out of mind,” she said.