By Chuck Jaffe
Jan. 9, 2011, 12:01 p.m. EST
Fund investors, watch your wallets
Commentary: Cost-cutting firms deserve shareholder loyalty
BOSTON (MarketWatch) — When a mutual fund company cuts management expenses on a stock fund, it really has something to crow about.
In fact, when the Buffalo Funds issued a press release about how the fees had been trimmed on both Buffalo Large Cap /quotes/comstock/10r!bufex (BUFEX 20.60, +0.17, +0.83%) and Buffalo Growth /quotes/comstock/10r!bufgx (BUFGX 25.80, +0.17, +0.66%) — two equity portfolios that get top marks for total return from fund-tracker Lipper Inc. — it was the first time in ages that I can recall stock-fund managers cutting their own pay.
Plenty of fund firms cut or waive fees on bond- and money-market funds, mostly because it’s been about the only way to placate investors and hang onto their assets in the current low-yield environment.With stock funds, it’s a different story. “Break points” — the asset levels where many funds automatically adjust fees — work in both directions. So when assets rise, costs should go down. But at many funds where assets have been shrinking, costs have increased.
To get the most from your investments, costs matter. Management fees come off the top of returns — expenses that are paid regardless of returns, and which add to a loss during tough times.
How a fund looks at its expenses is also telling. That’s why the Buffalo Funds announcement was so noteworthy, and why it sends investors a clear message on how to re-evaluate fund fee structures.
“This should be a win-win,” said Kent Gasaway, Buffalo’s president. “We have two funds that have great ratings; lowering fees is a win for investors, but if more people know about the funds, find the pricing competitive and invest, then obviously that is a win for the company.”
Net operating expenses for Buffalo Growth dropped to 0.94% from 1.04%% and to 0.99% from 1.09% at Buffalo Large Cap. Gasaway noted that if the firm succeeds in growing assets, the costs for the two funds could drop as low as 0.9%. Diversified U.S. stock funds charge about 1.4% on average.
‘Lose-win’ situation
Cost cutting is anything but standard practice in the fund business. Indeed, if you consider Gasaway’s view that fee cuts are a “win-win,” then what investors are getting from many funds is a “lose-win” — where they’re saddled with higher costs, which is good for the fund. Investors don’t sweat costs when returns are healthy, but being in a “lose-win” situation is never good.
So fund investors should be asking themselves — and maybe the service representatives of their fund firms — if the fees they are paying are fair and reasonable, and if management wants to be in win-win mode.
Clearly, competition affects costs. There’s a reason why the three largest fund firms have among the lowest costs in the business. With exchange-traded funds, low management fees build reputations, which has resulted in costs being driven down to bargain levels.
While that hasn’t happened to the same extent in traditional funds, that doesn’t mean investors should overpay. You don’t want a fund axing critical research analysts and staff in order to drop costs, but you’d like to see a management that is confident in its ability to deliver results, which in turn attracts more assets.
Send a message
“When so many funds are delivering benchmark-like results — when you can do as well or better being in an index fund — it’s reasonable for people to focus on expenses,” said Geoff Bobroff, an industry consultant in East Greenwich, R.I. “The industry squeezed everything it could from service providers — cutting basic costs — but you’d like to see management participate in bringing down costs in some way. … They’re sending a message when they cut fees — and when they don’t.”
If your fund performance has been disappointing and your fund expenses have remained static; if management has not waived costs, put off the break-point fee reversal “earned” by shrinking assets, or has not shown you that it wants you to “win,” it may be time to look elsewhere. The only way the fund industry will ever embrace consumer-oriented thinking is if shareholders keep management’s feet to the fire.“Cutting costs, when you can, is good business,” said Buffalo’s Gasaway. “If management is greedy, it should come back to haunt them. Everyone says that they are there for the shareholders, but watch their actions. We’re shareholders ourselves; we know that keeping costs down whenever possible is the right thing to do.”
Chuck Jaffe is a senior MarketWatch columnist. His work appears in many U.S. newspapers.
