Trading costs on mutual funds outweigh commission fees for investors, experts say

Concerns arise when managers make trades because of hefty cash flows

May 29, 2009 @ 2:14 pm

By Lisa Shidler

With many managers failing to generate strong returns, trading costs are harder for investors to stomach.

Often-ignored trading costs for mutual funds add an average of 1.64%, making positive returns even more difficult to achieve, said Arijit Dutta, associate director of fund analysis at Morningstar Inc. in Chicago.

He and Roger Edelen, assistant professor at the University of California, Davis Graduate School of Management, spoke today at Morningstar’s annual investment conference in Chicago.

Typically, investors and advisers worry about commission costs associated with a mutual fund, but trading is much costlier, Mr. Edelen said.

Concerns arise when managers make trades because of hefty cash flows, not because they want to add value to the fund, he said.

“Some funds have a high hurdle to overcome because of the costs,” Mr. Edelen said. “This doesn’t mean that active management is dead; it just means that they have a [high] hurdle to overcome."

Mr. Edelen said commission costs pale in comparison with the costs that are added by trading, particularly when fund managers buy stocks because they have an added supply of cash.

He said trading costs add up because managers start to buy a stock one day and continue to buy that same stock for several days.

By the time they’ve finished purchasing the stock, they have driven up the price of the stock, and it is much more expensive than it was when they first bought it, Mr. Edelen said.

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