Vermont Bar Journal, Vol. 40, No. 2 Spring 2015, Vol. 41, No. 1 | Page 32

A Broken Marketplace
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the mutual fund distribution system center
on disclosure. As long as load and 12b-1
fees are described in the prospectus they
are allowed. Is the average investor going
to read a mutual fund prospectus? Probably not. The average investor will probably
look at their monthly statement. The statement, however, will not explicitly show load
and 12b-1 fees.
How many combinations of loads and
12b-1 fees might a single mutual fund offer? Most offer five or six; some three times
that. The name of the fund will be the same
in every case. In fact the underlying portfolio will be the same. The only differences are the type and size of the loads and
the kickback arrangement for 12b-1 fees.
Investors beware. You must know the symbol of the fund you own and then go to the
prospectus or a resource like Morningstar
to see the damage.
Have mutual fund companies and their
brokers been successful at hiding fees? We
would argue yes. As proof look no further
than the market for S&P500 index funds.
What’s a fair price to pay for an S&P500
index fund? An index fund is a commodity. The mutual fund manager simply buys
and holds the stocks in the index in proportion to their market value. There is virtually no difference between one S&P500 index fund and another ... except for the way
they are distributed and the fees that are
extracted. As of December 31, 2014, there
are ninety-two index funds that track the
S&P500 index. As can be seen in the table
below, the annual expense ratios vary enormously. Rydex’s C shares top the chart at
2.32% per year. Fidelity, in a price war with
Vanguard, is the lowest at 0.02%. If there
ever was proof that the market for mutual
funds is broken; this is it.
If you were buying a commodity - say a
bag of rice - would you expect to see some
offerings more than one hundred times
more expensive than others? Most of the
high-expense S&P500 index funds are offered by insurance company affiliates that
pay up to 1% per year in 12b-1 fees to the
selling broker. Would this be possible if
clients were aware they are paying these
fees? There is no doubt in our minds that
the answer is no. It is like all the bags of
rice seemingly sell for the same pr X