Fund group says rule review could have merit

WASHINGTON — The radical notion of abolishing mutual fund boards and allowing funds to set their own prices may be worth a second look, according to the head of a group representing independent fund directors for the $10.4 trillion fund industry.
“If there is an alternative that is maybe somehow more efficient, less costly or provides a different approach used in other jurisdictions, maybe we should all study it,” said Amy Lancellotta, managing director of the Independent Directors Council, which is part of the Washington-based Investment Company Institute, the mutual fund industry’s powerful trade group.
Her comment came in response to last week’s release of a book calling for deregulation of the mutual fund industry. The book, “Competitive Equity: A Better Way to Organize Mutual Funds,” by Peter Wallison and Robert Litan (AEI Press), suggests that funds would be more competitive if they operated without boards of directors and instead relied on full-time trustees to look out for the interests of shareholders.
Ms. Lancellotta disagrees, however, with the book’s claim that directors impede fee reductions.
Besides, “independent directors do more than just approve advisory fees,” she said. “They also oversee potential conflicts to ensure that advisers’ interests are aligned with shareholders’.”
The book’s authors endorse a free-market approach in which fund companies would be allowed to set fees without input from directors, as is the practice in the United Kingdom.
Allowing fund companies to set their own fees would lead many to adopt a simplified “all-in” fee that would be easier for investors to understand, the book asserts.
“I do think that a single fee is a very promising idea that warrants further exploration,” said Susan Wyderko, executive director of the Mutual Fund Directors Forum in Washington, which represents independent directors and is not associated with the ICI. “The best alternative would be to gain the best of both worlds, and have a single fee and have independent directors participate in the negotiation of that single fee.”
Not surprisingly, however, Ms. Wyderko opposes the notion of doing away with fund boards. She points to evidence that fund fees are higher on average in the United Kingdom than in the United States as a reason to reject the book’s thesis.
“In view of the substantial discrepancy in the prices of U.K. funds and American mutual funds, it would seem that the best alternative would be to gain the best of both worlds and have a single fee, and have independent directors participate in the negotiation of that single fee,” Ms. Wyderko said.
The average cost for the Class A shares of 1,668 U.S. stock funds, according to Annette Larson, senior research analyst at Chicago-based Morningstar Inc., is 1.3% of assets. Although an exact comparison is not available, she estimates the average cost for 1,681 stock funds domiciled in the United Kingdom to be 1.7% of assets.
Fees there may be higher because the industry is smaller, and its costs are greater, Mr. Wallison said at a presentation at the American Enterprise Institute for Public Policy Research’s headquarters in Washington last week. More important than the average level of fees is the fact that the range of
fees among U.K. funds is more narrow, which suggests that the funds compete more on price, he told InvestmentNews.
Even so, some financial advisers are skeptical of the notion that eliminating fund directors would benefit investors.
“If we really want competition on fees, we need fee transparency,” said F. John Deyeso, a certified financial planner with financial filosophy, a New York firm. “Getting rid of the advisory board doesn’t necessarily create transparency.”
Rick Miller, an adviser with Cambridge, Mass.-based Sensible Financial Planning and Management LLC, also doubts whether the elimination of fund boards would lead to more competitive pricing.
“If you want the funds to compete on price, let’s tell people what they’re paying,” he said. “It would be very simple to do that.”
Mr. Wallison, a senior fellow at the American Enterprise Institute, and Mr. Litan, a senior fellow at The Brookings Institution in Washington, maintain that the fund industry is not competitively priced.
That’s because boards approve fund advisers’ fees based largely on an advisory firm’s cost of doing business, plus a return. That process has led to a 300% disparity in fees among the 811 stock funds examined by the study’s authors, Mr. Wallison said at a presentation at his institute’s headquarters Monday.
Even Standard & Poor’s 500 stock index funds show wide price variations, and higher-priced funds perform worse than those that are lower priced, according to the authors’ findings.
In contrast, the United Kingdom equivalent of mutual funds show less fee variance, Mr. Wallison said. While he acknowledged that U.K. funds are more expensive on average, that could be because the U.K. fund industry is smaller, he said.
Mr. Wallison and Mr. Litan said that the Securities and Exchange Commission’s effort to require more independence on fund boards is misguided.
Insisting on greater board independence is “actually making things worse,” Mr. Wallison said at the AEI presentation. As directors challenge advisers more on the question of pricing, “the less likely it is that the advisers are going to want to take the risk of cutting their costs and competing on price,” since advisers often are not able to receive any benefit from cost cutting, and it could result in reduced profits, he said.