New accounting standards proposed by the Financial Accounting Standards Board could give index funds a substantial advantage over actively managed funds, experts said.
FASB put out the proposal — which would force investment management companies to list their trading costs as expenses — for comment earlier this year. Currently, investment management companies record these costs as a loss on their investments on their statements of operations. The proposed change, however, would require funds to include traction costs in their expense ratios. Investors often choose funds based on these charges.
“Funds that are more index-oriented or closet index-oriented are going to stand out even more as low-cost alternatives to actively managed funds, which would see their expense ratios jump significantly in some cases,” said Todd Rosenbluth, a mutual fund analyst at Standard & Poor's Financial Services LLC.
The Vanguard Group Inc., T. Rowe Price Associates Inc., Franklin Templeton Investments and Blackrock Inc. are among the 14 mutual fund companies to write letters opposing the proposal. The Investment Company Institute also sent in a comment letter voicing its opposition.
Their arguments? For starters, funds with higher trading activity will appear more expensive than those that trade less frequently, even though that might not be case, according to a letter to FASB from Laura F. Ferguson, senior vice president of Franklin Templeton Services, LLC.
What's more, the proposal could make it more difficult for investors to compare fund expenses over different periods of time. Typically, a portfolio manager for a newly launched fund makes more transactions than a more mature fund, the Franklin Templeton manager wrote in her letter.
The proposal also doesn't provide any clarity on how firms would expense the trading costs for fixed income funds. Unlike equity funds, which pay explicit commissions to brokers to make trades, fixed-income funds buy and sell securities over the counter, where trades are made on a bid-ask spread basis.
“Practically speaking, it would be extremely difficult for funds to develop the contemporaneous fair-value measurements for fixed-income securities that would be required under the proposal,” wrote Gregory M. Smith, director of operations, compliance and fund accounting at the ICI.
The comment period for the proposal ended Sept. 30.
