Let competition, not boards, set advisory fees

Abolishing the role of mutual fund boards of directors in approving advisory expense ratios would lead to more competition in mutual fund fees, according to a book released in Washington today.
After holding seminars on mutual fund regulation since September 2005, the American Enterprise Institute for Public Policy Research and the Brookings Institution released their book, “Competitive Equity: A Better Way to Organize Mutual Funds,” at the 11th and final seminar on the issue.
The book, by AEI senior fellow Peter Wallison and Brookings senior fellow Robert Litan, is one of the first studies undertaken on the effect of public policies on mutual fund pricing.
Among 811 equity funds, expense ratios vary by as much as 300%, an unusually large price discrepancy in an industry that otherwise should be very competitive, the authors found. There are about 8,000 mutual funds operating in the United States, with $10.4 trillion in assets.
Moreover, funds that perform poorly charge the most, while funds that have the best performance charge the least, the authors said. While the expense ratios appear small, charging investors more than they would otherwise have to pay in a more competitive market means investors have substantially less to retire on, the authors stressed.
“In essence we’ve concluded regulation is the reason for the absence of price competition,” said Mr. Wallison.
Mutual fund boards function much like public utility commissions that regulate electric companies, Mr. Wallison said. Mutual fund advisers have little incentive to cut costs because, if they fail to attract more investors, they will not be able to go back to boards and argue that their costs have risen, he said. That could mean they would risk cutting their profits.
The authors suggested that the United States try a system like the United Kingdom, which they call managed investment trusts, which are managed by banks using full-time trustees. Board would not have the power to approve advisory fees, and advisers would have more incentive to compete by lowering fees, or prices, in the same way other industries do, they argue.