A cap on 12b(1) fees is going to have one predictable result. Think carnival games.
What consumers need is not a cap, but some sunshine to disinfect mutual funds
4 min read- SEC's 12b(1) fee cap likely shifts costs to other hidden mutual fund expenses.
- Mutual funds average 3% in total annual expenses, exceeding advertised management fees.
- Transparency remains key; Investment Company Institute resists full fee disclosure.
- Expect rising fees and obscured costs without comprehensive transparency mandates.
The interaction between the SEC and mutual fund companies reminds me of Whac-A-Mole. Every time the SEC cracks down on one fee or expense it only pops up somewhere else. The same thing is likely to happen if the SEC goes ahead with its proposal to limit 12b(1) fees to 0.25% of a mutual fund’s assets under management.
The annual 12b(1) (“marketing”) fee was introduced in 1980 as an alternative to lump sum “sales loads” that previously represented the dominant way mutual funds funded their sales and marketing efforts. The expectation was that reimbursing marketing expenses would increase assets, which in turn would lower overall marketing expenses as a percentage of assets. Ultimately, this “economies of scale” model was intended to “help” investors, but the reality is these fees do nothing to enhance the net performance of the fund.
That’s because there’s no such thing as a free lunch.
How the new 12b(1) fee restrictions could transform the financial advisory industry
Mutual fund distributors have promoted services that eliminate sales loads, but what consumers never seemed to realize is that the lower the sales load, the higher the 12b(1) (and vice versa). The disconnect between the initial intention for a marketing fee and the reality of its ultimate abuse led the SEC to propose a fee cap last month – but the multitude of mutual fund fees and the ease with which companies can raise them mean that a 12b(1) fee cap is unlikely to help consumers in the long run.
Most of those fees are hidden in the fine print of lengthy, confusing mutual fund agreements. Earlier this year, kaChing conducted a study with data provided by Lipper Inc., the leading mutual fund market research firm, to identify all the potential fees incurred by actively managed mutual funds. While all funds advertise low management fees, they are just the tip of the iceberg. We found that the total annual expenses associated with actively managed mutual funds are approximately 3%.
Story Timeline
The cost of investing in an actively managed mutual fund can include:
• Management fees
• Trade commissions
• Soft dollar commissions
• Marketing fees (12b(1) Fee)
• Front-end loads
• Back-end loads
• Other expense fees (Non-management fees)
• Embedded tax liabilities
You can be sure that any cap on 12b(1) fees will result in another fee/expense component rising.
While the SEC aims to make fees clearer to investors, it isn’t directly addressing the reality that investors will never be free from extraneous, hidden fees unless all fees are made transparent. See: How the new 12b(1) fee restrictions could transform the financial advisory industry It’s pretty simple. Without transparency, the types of fees incurred and fee amounts will just continue to increase. And in the cases where fees are capped in one area, we’ll likely see them migrate into another fee category as a new iteration of the same old hidden fee.
Who could possibly oppose transparency? Unfortunately the Investment Company Institute (the mutual fund trade association/lobbying group). For years, the SEC tried to get mutual fund companies to disclose their turnover because commissions can have a big impact on a fund’s performance. Last year the SEC finally prevailed, but the ICI succeeded in keeping the impact on performance from being disclosed because “it will only confuse the consumer.” It’s laughable to suggest that an informed consumer equates to a confused customer. Sunshine is the best disinfectant, but it will shine on mutual fund fees only if the SEC has the guts to stand up to the lobbyists.
Andy Rachleff, chief executive of Palo Alto-based KaChing, brings over 25 years of experience in building and growing companies in the technology industry. Prior to joining kaChing, Mr. Rachleff co-founded and was a general partner at Benchmark Capital. Mr. Rachleff received his MBA from the Stanford Graduate School of Business where he is now a member of the faculty. He earned his bachelor’s degree from the University of Pennsylvania where he is currently a member of the Board of Trustees and the University’s Endowment Investment Board.
Brooke’s note: For more on this article’s author, Andy Rachleff, see Can Silicon Valley rewire the RIA business? eBay investors think KaChing is the answer
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