Alan Reynolds

While watching the news on a trip to New York City, I happened upon State Attorney General Elliot Spitzer being interviewed by NBC's Gabe Pressman. Spitzer was tossed a softball about his next crusade against Wall Street, as though no month should ever again go by without more financial firms being accused of something or other. Spitzer then began to rant on cue about mutual fund fees being exorbitant, unfair and biased against the little guy.

Always one to overreach, Spitzer has clearly gone overboard this time. As UCLA law professor Steven Bainbridge points out, "N.Y. Attorney General Elliot Spitzer has no power -- none, nada, zilch -- to regulate mutual funds fees." To be more precise, he has "no constitutional right, statutory authorization or common law power" to tinker with such fees.

What Spitzer might be able to do, though, is to persuade Congress or the SEC to adopt his ill-considered solutions to this ill-defined problem. In testimony before the Senate banking committee a few weeks ago, Spitzer proposed that mutual funds be required to disclose "the precise dollar amount of fees charged to each investor ... (for) advisory, management, marketing and other administrative costs. Armed with this knowledge, investors can begin to engage in true comparison shopping among funds."

The idea is chimerical. Investors could not possibly compare "precise dollar amounts of fees" because only their own fund would provide such figures. Investors can't compare dollars, but they can easily compare percentages. Morningstar explains that all these fees "are included in the expense ratio, which is the most commonly used measure of a fund's overall expenses and a figure that is frequently used to compare mutual fund costs."

Many newspapers and magazines publish quarterly comparisons of mutual funds that include each fund's ratio of expenses to investments. Nobody but Spitzer cares how these expenses are split between marketing and advice. We care only about total expenses and only to the extent they affect total returns. This information is readily available in many published sources, and in every mutual fund prospectus. It's a lot easier than comparing lawyers' fees.

Nearly every newspaper also publishes daily figure on how each mutual fund is doing so far this year, and those results always subtract fees. If fees result in subpar returns, investors will switch to other funds that perform better with or without lower fees. If any fund's blend of returns and risk continues to attract investors, that means its fees are acceptable to its investors. The mutual fund business is extremely competitive and transparent.


Alan Reynolds

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