Morningstar’s Paul Ellenbogen laments the difficulty investors face when trying to compare fund fees. Ellenbogen and his Morningstar colleague John Rekenthaler offer three suggestions to help investors better understand fund fees.
- Fee categorization. First, the pair would break down the fees into five categories: portfolio management, administrative, operational, distribution, and advice. By arranging the expenses in the prospectus into clear categories and also providing “an equal-weighted mean of funds sharing the same broad asset class” for comparison would, according to Ellenbogen and Rekenthaler, help investors to better understand what they are paying for and more easily compare funds. The article also provides some examples of how expenses would be categorized.
The two suggest that the “administrative” category only contain “internal” administrative costs assessed at the fund level rather than charges that are assessed at the share-class level and eventually passed on to affiliates that are sometimes lumped into the category. They argue that this change would also assist fund boards in the 15(c) process to better understand the profitability of the portfolio management function. Further, they propose that the term “12b-1” should be eliminated from shareholder communications. Instead, the authors propose designating fees according to the purpose they serve to investors.
- Share class disclosure. Ellenbogen and Rekenthaler also suggest a simple grid of the available share classes that would display the level of operational, distribution, and advisory fees, as well as any investment minimums or eligibility requirements. The authors propose the change in response to the proliferation of available share classes, coupled with the difficulty investors have in discerning the differences in fees and services associated with each class.
- Disclose expenses in dollar terms. Lastly, they propose that expense information include the actual dollar cost to the specific investor for each category of expense. In addition, Ellenbogen and Reckenthaler propose including a chart demonstrating the effect of the difference between the fund’s fee and the industry average fee on the investor’s return over time. The article argues that current fee disclosures have little value because the information is not tailored to the investor’s specific needs.
The full article can be found here.