As much as journalists love anniversaries, we’re in danger of letting one slip by unnoticed this year.
Let’s correct that oversight right now. Happy 20th birthday, mutual fund 12b-1 fees!
Since these fees for fund distribution expenses were authorized in 1980 by the Securities and Exchange Commission, under Section 12b-1 of the Investment Company Act of 1940, they have won few friends outside the fund management firms that collect them.
“One thing that is really important to me is the rip-off to individual investors of 12b-1 fees,” investor Katy Filicky wrote SEC Chairman Arthur Levitt Jr. on the regulatory agency’s Web site earlier this year.
The rule that arouses such antipathy permits management firms to collect an annual fee from the assets of the funds they advise to pay brokers and others involved in selling shares to investors. This is separate from, and never to be confused with, the management fee for running the fund’s investments.
The charge can run as high as 1 percent of a fund’s assets per year. If it’s 0.25 percent or less, the fund can still call itself “no-load.”
The funds’ largest trade association, the Investment Company Institute, says more than half of all fund groups have at least one fund with a 12b-1 plan. The number appears to be on the rise lately, as numerous fund firms look for ways to induce brokers and other intermediaries to keep pushing their merchandise.
No-load funds are sold increasingly through paid advisers, or in discount brokerage “marketplaces” at firms such as Charles Schwab & Co. that charge fund managements what amounts to a listing fee. If fund managers want the shareholders to bear this burden, hey, they can set up a 12b-1 plan.
Load funds, meanwhile, must now sometimes pass up their customary up-front commission, as when they sell shares through employer-sponsored 401(k) retirement savings programs. Bring on the 12b-1!
“Sadly, the clammy hand of 12b-1 fees has grabbed fund companies that formerly steered clear of such nonsense,” said Peter Di Teresa, a senior analyst at Morningstar Inc., in a commentary on the Chicago research firm’s Web site at www.morningstar.com.
According to an ICI survey, 95 groups with some form of 12b-1 fees at the end of last year spent 63 percent of the money they collected to pay broker-dealers; 32 percent for administrative services provided by outside firms for existing fund shareholders, and the other 5 percent for advertising and sales promotion.
Years ago, apologists tried to argue that more money in the fund brought existing shareholders the benefit of greater economies of scale that is, lower operating costs per dollar invested. But this idea of a fee that saves you money never flew.
The main benefit of increased assets goes to the manager, whose fee for running the fund is likewise set as an annual percentage of the total in the fund. Isn’t it logical to ask this manager, operating in one of the most lucrative businesses anywhere, to bear the cost of building the pot?
Another situation that only stokes the fire: Funds that close to most new investors, but continue collecting money in their 12b-1 plans.
What’s an investor to do? You can check the fee table at the front of every fund prospectus for 12b-1 fees, and refuse to buy any fund that even authorizes the practice. That’s a fine way to stand up for a principle. But crossing half the funds on the market off your list may cost you some good opportunities.
Better, maybe, to compromise and remain willing to consider 12b-1 funds as long as they don’t charge more than 0.25 percent, and otherwise go easy on the management fees.
Chet Currier is a columnist for Bloomberg News.
Small-Caps Can Ease Pain of ‘Tech Wrecks’
You won’t hear investors in small-capitalization value mutual funds complaining about the dizzying swings of the stock market indexes this year.At no point since the start of 2000 has the typical small-cap value fund shown either a gain or a loss of as much as 10 percent.
Put that up against an average small-cap growth fund, which was up about 25 percent in early March, then down nearly 10 percent by mid-April before bouncing into positive territory again.
Small-cap value investing isn’t just quiet, it’s practically deserted. At last report from the research firm Morningstar Inc. in Chicago, the 233 funds that try to find overlooked stock bargains among small companies had total assets of $33.7 billion.
That’s slightly more than one-quarter of the $128 billion in small-cap growth funds. Out of every $100 that investors have in domestic stock funds of all types, $1.19 reposes in small-cap value funds.
It’s no mystery why. Small-cap value funds have about 14 percent of their money in “technology” stocks, Morningstar calculates, compared to 46 percent at small-cap growth funds.
The Russell 2,000 Growth Index, a gauge of small stocks with relatively high earnings forecasts and ratios of price to book value, returned 43 percent last year, while the Russell 2,000 Value Index, made up of small stocks with lower valuations, slipped 1.5 percent.
None of these small value funds may help you take advantage of the Internet bonanza, whatever form that might take. But they’re a good bet to soften the shock of the next tech wreck.
Chet Currier
