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A LETTER FROM ICI'S
CHIEF ECONOMIST

ICI RESEARCH:
STAFF AND PUBLICATIONS

SECTION 1:
OVERVIEW OF
U.S.-REGISTERED INVESTMENT COMPANIES

SECTION 2:
RECENT MUTUAL FUND TRENDS

SECTION 3:
EXCHANGE-TRADED FUNDS

SECTION 4:
CLOSED-END FUNDS

SECTION 5:
MUTUAL FUND FEES AND EXPENSES

SECTION 6:
CHARACTERISTICS OF MUTUAL FUND OWNERS

SECTION 7:
THE ROLE OF MUTUAL FUNDS IN RETIREMENT AND EDUCATION SAVINGS

DATA TABLES

APPENDIX A:
HOW MUTUAL FUNDS AND INVESTMENT COMPANIES OPERATE

APPENDIX B:
ICI STATISTICAL RELEASES AND RESEARCH PUBLICATIONS

APPENDIX C:
SIGNIFICANT EVENTS IN FUND HISTORY

TIMELINE:
SIGNIFICANT EVENTS FOR FUNDS IN THE FINANCIAL CRISIS

GLOSSARY

FACT BOOK ARCHIVE

Mutual fund investing involves two primary kinds of fees and expenses: sales loads and ongoing expenses. Sales loads are one-time fees—paid directly by investors either at the time of share purchase (front-end loads) or, in some cases, when shares are redeemed (back-end loads). Ongoing fund expenses cover portfolio management, fund administration, daily fund accounting and pricing, shareholder services such as call centers and websites, distribution charges known as 12b-1 fees, and other miscellaneous costs of operating the fund. Unlike sales loads, ongoing expenses are paid from fund assets, and thus investors pay them indirectly. A fund’s expense ratio is its annual ongoing expenses expressed as a percentage of fund assets.

Trends in Mutual Fund Fees and Expenses

To understand trends in mutual fund fees and expenses, it is helpful to combine major fund fees and expenses into a single measure. ICI created such a measure by adding a fund’s annual expense ratio to an estimate of the annualized cost that investors pay for one-time sales loads. This measure gives more weight to those funds that have the most assets.

Mutual fund fees and expenses that investors pay have trended downward since 1980. In 1980, investors in stock funds, on average, paid fees and expenses of 2.32 percent of fund assets. By 2008, that figure had fallen by almost 60 percent to 0.99 percent (Figure 5.1). Fees and expenses paid on bond funds have declined by a similar amount.

FIGURE 5.1

Fees and Expenses Incurred by Stock and Bond Mutual Fund Investors Have Declined Since 1980

Percent, selected years

Download an Excel file of this data.

*Variable annuities and mutual funds that invest primarily in other mutual funds are excluded. Figure reports asset-weighted average of annual expense ratios and annualized loads for individual funds.
Sources: Investment Company Institute; Lipper; ValueLine Publishing, Inc.; CDA/Wiesenberger Investment Companies Service; Data © CRSP University of Chicago, used with permission, all rights reserved (312.263.6400/www.crsp.com); and Strategic Insight Simfund

There are several reasons for the dramatic drop in the fees and expenses incurred by mutual fund investors. First, investors generally pay much less in sales loads than they did in 1980. For example, the maximum front load that an investor might pay for investing in an equity fund has fallen from an average of 7.9 percent of the investment in 1980 to 5.3 percent in 2008. The front-end loads that equity fund shareholders actually paid have fallen even more, from 5.5 percent in 1980 to only 1.1 percent in 2008. A key factor in the steep decline in loads paid has been the growth of mutual fund sales through employer-sponsored retirement plans. Load funds often do not charge loads for purchases of fund shares through such retirement plans.

Another reason for the decline in the fees and expenses of investing in mutual funds has been the growth in sales of no-load funds. Much of the increase in sales of no-load funds has occurred through the employer-sponsored retirement plan market. Sales of no-load funds have also expanded through mutual fund supermarkets and discount brokers.

Finally, mutual fund fees have been pushed down by economies of scale and competition within the mutual fund industry. The demand for mutual fund services has increased dramatically since 1980. From 1980 to 2008, the number of households owning mutual funds rose from 4.6 million to 52.5 million, and the number of shareholder accounts rose from just 12 million to about 265 million. Ordinarily, such a sharp increase in the demand for fund services would have tended to limit decreases in fund expense ratios. This effect, however, was more than offset by the downward pressure on fund expense ratios from competition among existing fund sponsors, the entry of new fund sponsors into the industry, economies of scale resulting from the growth in fund assets, and shareholder demand for lower cost funds.

Shareholder Demand for Lower-Cost Funds

Focusing only on fund expense ratios, ICI research still indicates that mutual fund shareholders invest predominantly in low-cost funds. This can be seen by comparing the average expense ratio on mutual funds offered in the marketplace with the average expense ratio mutual fund shareholders actually paid (Figure 5.2). The simple average expense ratio of stock funds (which measures the average expense ratio of all stock funds offered in the market) was 1.44 percent in 2008. The average expense ratio that stock fund shareholders actually paid (the asset-weighted average expense ratio across all stock funds) was considerably lower: just 0.84 percent of stock fund assets. Thus, investors actually paid expense ratios at the lower end of the range of funds available in the market.

FIGURE 5.2

Fund Shareholders PaID Lower-Than-Average Expense ratios in
Stock Funds1

1994–2008

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1Variable annuities and mutual funds that invest primarily in other mutual funds are excluded.
2Figure reports asset-weighted average of annual expense ratios for individual funds.
Sources: Investment Company Institute; Lipper; ValueLine Publishing, Inc.; CDA/Wiesenberger Investment Companies Service; Data © CRSP University of Chicago, used with permission, all rights reserved (312.263.6400/www.crsp.com); and Strategic Insight Simfund

Another way to illustrate that investors demand mutual funds with low expense ratios is to identify how investors allocate their new purchases of mutual fund shares. During the 10-year period from 1999 to 2008, more than 100 percent of the new cash flowing to stock funds went to those funds whose expense ratios were below average, while funds with above average expense ratios as a
group experienced outflows (Figure 5.3). This was true for both actively managed funds and index mutual funds.

FIGURE 5.3

Stock Funds with Below-Average Expense Ratios ReceiveD 102 Percent of Net New Cash*

Percentage, 1999–2008

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*Variable annuities and mutual funds that invest primarily in other mutual funds are excluded.
Sources: Investment Company Institute; Lipper; ValueLine Publishing, Inc.; CDA/Wiesenberger Investment Companies Service; Data © CRSP University of Chicago, used with permission, all rights reserved (312.263.6400/www.crsp.com); and Strategic Insight Simfund

Factors Influencing Mutual Fund Fees and Expenses

As is true of the prices of most goods and services, fees differ considerably across the range of mutual funds (Figure 5.4). The level of fund fees depends on the fund investment objective, fund assets, balances in shareholder accounts, the number and kinds of services that a fund offers, and other factors.

FIGURE 5.4

Expense Ratios for Selected Investment Objectives*

Percent, 2008

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*Variable annuities and mutual funds that invest primarily in other mutual funds are excluded.
Sources: Investment Company Institute; Lipper; Data © CRSP University of Chicago, used with permission, all rights reserved (312.263.6400/www.crsp.com); and Strategic Insight Simfund

FUND INVESTMENT OBJECTIVE. Expenses vary by type of fund; for example, bond and money market funds tend to have lower expense ratios than equity funds. Among equity funds, expense ratios tend to be higher among funds that specialize in particular sectors (“sector” funds), such as healthcare or real estate, or those that invest in international stocks, which tend to be more costly to manage than, for instance, stocks in the S&P 500 index.

Even within a particular type of fund, there can be considerable variation in fund expense ratios. For example, 10 percent of aggressive growth equity funds have expense ratios of 0.89 percent or less, while 10 percent have expense ratios of 2.24 percent or more. Such variation in part reflects the fact that such funds are not all identical. Some aggressive growth funds may choose to focus more on small- or mid-cap stocks while others may focus more on large-cap stocks. This can be significant because small- and mid-cap stocks tend to be more costly to manage.

FUND AND AVERAGE FUND ACCOUNT SIZE. Other factors—such as fund size and fund account size—also help explain differences in fund expense ratios.

All else equal, large mutual funds tend to have lower-than-average expense ratios because of economies of scale. Fund sizes vary widely across the industry. In 2008, the median long-term mutual fund had assets of $157 million (Figure 5.5). Twenty-five percent of all long-term funds had assets of $45 million or less, while another 25 percent of long-term funds had assets greater than $536 million.

FIGURE 5.5

Fund Sizes and Average Account Balances VarIED Widely*

Long-term funds, year-end 2008

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*Variable annuities and mutual funds that invest primarily in other mutual funds are excluded.
Note: Number of shareholder accounts includes a mix of individual and omnibus accounts.

Funds with higher account balances also tend to have lower expense ratios than other funds. This reflects the fact that each account, regardless of how large or small it is, requires a given, relatively fixed level of service. For example, account statements must be mailed periodically to account holders. Funds that cater primarily to institutional investors—who typically invest large amounts of money in fewer accounts—tend to have high average account balances. Many funds primarily serve retail investors, who typically have lower average account balances. In part because of this, account balances, like fund sizes, range considerably across the industry. In 2008, 50 percent of long-term funds had average account balances of less than $40,255. Twenty-five percent of long-term funds had average account balances of less than $16,426. At the other extreme, 25 percent of funds had average account balances of more than $135,245.

PAYMENTS TO INTERMEDIARIES. Another factor that helps explain variation in fund fees is whether funds are sold through intermediaries, such as brokers, or registered financial advisers. These professionals help investors define their investment goals, select appropriate funds, and provide ongoing advice and service. Financial advisers are compensated for these services, in part, through a particular kind of fund fee, known as a 12b-1 fee, which is included in a fund’s expense ratio. Funds sold through intermediaries tend to have higher expense ratios than other funds (no-load funds). No-load funds are sold directly to investors or are sold to investors through financial advisers who charge investors separately for investment advice. Thus, no-load funds tend to have lower expense ratios than other funds with similar investment objectives.

FIGURE 5.6

Investor Assets WERE Concentrated in S&P 500 Index Mutual Funds
with the Lowest Expense Ratios

Percentage of total assets of S&P 500 index mutual funds, year-end 2008

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Note: Percentages do not add to 100 percent because of rounding.
Sources: Investment Company Institute and Lipper

FIGURE 5.7

Investors’ Net Purchases of S&P 500 Index Mutual Funds WERE Concentrated in Least Costly Funds

Percentage of net new cash flow of S&P 500 index mutual funds, 1999–2008

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Note: Percentages do not add to 100 percent because of rounding.
Sources: Investment Company Institute and Lipper

Rule 12b-1 Fees

Many mutual fund investors use and pay for the services of a professional financial adviser. ICI research finds that among investors owning mutual fund shares outside of retirement plans at work, 77 percent own fund shares through professional financial advisers. Financial advisers typically devote time and attention to prospective investors before they make an initial purchase of funds and other securities. The adviser generally meets with the investor, identifies financial goals, analyzes existing financial portfolios, determines an appropriate asset allocation, and recommends funds to help achieve the investor’s goals. Advisers also provide ongoing services, such as periodically reviewing investors’ portfolios, adjusting asset allocations, and responding to customer inquiries.

Until about 30 years ago, fund shareholders could only compensate financial advisers for their assistance through a front-end load—a one-time, upfront payment made to financial advisers for both current and future services. After 1980, when the U.S. Securities and Exchange Commission (SEC) adopted Rule 12b-1 under the Investment Company Act of 1940, funds and their shareholders had greater flexibility in compensating financial advisers. The adoption of this rule, and subsequent regulatory action, established a framework under which mutual funds pay for some or all of the services that financial advisers provide to shareholders through so-called 12b-1 fees. This framework also allows mutual funds to use 12b-1 fees to compensate other financial intermediaries, such as retirement plan recordkeepers and discount brokerage firms, for services provided to fund shareholders, and to pay for advertising, marketing, and other sales promotion activities.

Nevertheless, most of the 12b-1 fees collected by funds were used to compensate financial advisers and other financial intermediaries for assisting fund investors before and after purchases of fund shares (Figure 5.8). Furthermore, only a small fraction (2 percent) of the 12b-1 fees that mutual funds collect was used for advertising and promotion.

FIGURE 5.8

Most 12b-1 Fees Used to Pay for Shareholder Services

Percentage of 12b-1 fees collected, 2004

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Source: Fundamentals, “How Mutual Funds Use 12b-1 Fees”

The amount of 12b-1 fees that shareholders pay through mutual funds rose from a few million dollars in the early 1980s to about $13 billion in 2008 (Figure 5.9). This increase reflects, in part, the roughly 70-fold increase in mutual fund assets and the 11-fold increase in the number of households owning funds since 1980. The increase in total 12b-1 fees also reflects a shift by mutual funds and their investors from front loads to 12b-1 fees as a mechanism to compensate financial advisers. For example, as noted earlier, the average maximum front-end load on all stock funds declined from 7.9 percent in 1980 to about 5.3 percent in 2008, the period during which Rule 12b-1 has been in place. Most load funds now also offer classes of shares that have 12b-1 fees but no front loads.

For more information on fund operations and the fees and expenses that funds charge, see Appendix A: How Mutual Funds and Investment Companies Operate and Fundamentals, “Trends in the Fees and Expenses of Mutual Funds, 2008” at www.ici.org/pdf/fm-v18n3.pdf. ICI also offers an investor education brochure explaining mutual fund fees and expenses at
www.ici.org/pdf/bro_mf_fees_faq_p.pdf.

FIGURE 5.9

Rise in 12b-1 Fees Paid Reflects Asset Growth and Shift in Source of Financial Advisers’ Compensation

Billions of dollars, selected years

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Note: Variable annuities and mutual funds that invest primarily in other mutual funds are excluded.
Sources: Investment Company Institute; Lipper; Data © CRSP University of Chicago, used with permission, all rights reserved (312.263.6400/www.crsp.com); and Strategic Insight Simfund