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Expense Ratios
Old 10-13-2005, 02:36 PM   #1
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Expense Ratios

Just read and article on Money.com.
Showed the diff. between normal expense ratios and active expense ratios.
Vanguard Explorer VEXPX* showed .72 normal and 5.40 active.
Vanguard Windsor 2 VWNFX showed .36 normal and 1.06 active.
Vanguard Wellington VWELX showed .36 normal and .94 active.

Can someone explains what this means and the effects on returns.


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Re: Expense Ratios
Old 10-13-2005, 03:34 PM   #2
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Re: Expense Ratios

I took a look at the article,

They didn't explain it with lots of clarity but my take is as follows:

Funds like Fidelity Magellan and lots of others basically mimick an index (the S&P500 index for Magellan). Only a small portion of their basket of stocks differ from the index. So if you remove the portion of the Magellan fund that mimicks the index you can do his calculation. If you take the extra expense ratio you pay the fund (over a low cost index fund) and divide it by the percentage of stocks in the fund that are different from the index you get "Millers Active Expense Ratio". - Did you get that ?

In other words, Millers Active Expense ratio shows what a whopping premium (on the expense ratio) you are paying for most managed funds compared to low cost index funds. This is especially true for funds like Magellan that basically mimick an index.
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Re: Expense Ratios
Old 10-13-2005, 04:24 PM   #3
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Re: Expense Ratios

MB,
I think I get it but are these expenses taken off before Vanguard posts the %'s earned for the year.
Let's say Wellington shows 9% for the year, are the higher expenses for active manage funds taken off the % before or after that %'s are posted?
How do they get away showing one expense ratio when other expenses are charged?
I always thought that Vanguard was up front with the charges.

Thanks
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Re: Expense Ratios
Old 10-13-2005, 04:45 PM   #4
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Re: Expense Ratios

73ss454:

I guess I didn't explain myself very well,

The Millers Active Expense Ratio isn't an extra charge to your account. To do that (compute expense charges) just use the normal expense ratio.

It is an indication of the expense ratio for that part of the mutual fund that is different from a straight index fund, considering the extra charges that a managed fund charges compared to a low-cost index fund.

If you could split your managed fund into two parts, One part being a low cost index fund (with a low expense ratio) and the other part being whats left over. The Millers Active Expense Ratio is the (theoretical) expense ratio on the second part (the non-index part) of your manged fund.

In other words, if a fund comes close to being an index, how much is the premium on those few stocks that are not the same as an index.

So upon examining Millers ratio, you'll see that you are paying dearly for the management of those stocks that are different from an index.
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Re: Expense Ratios
Old 10-13-2005, 05:18 PM   #5
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Re: Expense Ratios

MB
Where are the extra charges reflected?

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Re: Expense Ratios
Old 10-13-2005, 05:25 PM   #6
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Re: Expense Ratios

Again:

There are no extra charges. All the extra charges of a managed fund(compared to an index fund) are reflected in the larger (normal) expense ratio.

Perhaps one of the other posters, that is more articulate, could do a better job of explaining this.
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Re: Expense Ratios
Old 10-13-2005, 10:11 PM   #7
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Re: Expense Ratios

I think that this is the article by Jason Zweig.

I believe that this is the paper that Jason is referring to:

Measuring the True Cost of Active Management by Mutual Funds

Quote:
Abstract:

Recent years have seen a dramatic shift from mutual funds into hedge funds even though hedge funds charge management fees that have been decried as outrageous. While expectations of superior returns may be responsible for this shift, this article shows that mutual funds are more expensive than commonly believed. Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active funds management together in a way that understates the true cost of active management. In particular, funds engaging in closet or shadow indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index. This article derives a method for allocating fund expenses between active and passive management and constructs a simple formula for finding the cost of active management. Computing this active expense ratio requires only a fund's published expense ratio, its R-squared relative to a benchmark index, and the expense ratio for a competitive fund that tracks that index. At the end of 2004, the mean active expense ratio for the large-cap equity mutual funds tracked by Morningstar was 7%, over six times their published expense ratio of 1.15%. More broadly, funds in the Morningstar universe had a mean active expense ratio of 5.2%, while the largest funds averaged a percent or two less.
FYI - you can register for free to download the paper.

Here's a snippet from the paper on Fidelity's Magellan:

Quote:
Consider, for purposes of illustration, the Fidelity Magellan Fund at the end of 2004. Based on monthly data from the preceding three years, an investor could have replicated the risk and return characteristics of the fund (including its R2 of 99%) by placing 90.87% of his or her assets in an index fund that tracks the S&P 500 and the remaining 9.13% in an appropriately chosen marketneutral
investment. In this new portfolio, 99% of the variance of this portfolio is explained by the index and we can leverage it in a way that Magellan’s beta and variance are also replicated. If we then take 18 basis points as the expense ratio for the passive component of Magellan (the same ratio as the version of Vanguard’s S&P 500 index fund marketed to individual investors), Magellan might be seen as “overcharging” investors by 52 basis points on the passive component of its portfolio. If we were to assess those 52 basis points against the 9.13% of the portfolio that is actively managed, we would find that annual expenses account for 5.87% of those funds.
Also note the time period studied. I believe the paper only uses the 36 month period from 1/2002-12/31/2004. I think Miller's paper was more for a method of calculating active alpha, not necessarily to prove or disprove anything.

If you want to calculate the total expense ratio you pay for funds, just add the commissions and transaction costs ratio to the expense ratio. Barry Barnitz did this here [scroll down almost to the bottom of the page]. You can usually find info on the transaction costs in a fund's Statement of Additional Information [SAI].

- Alec
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Re: Expense Ratios
Old 10-15-2005, 07:55 PM   #8
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Re: Expense Ratios

Alex (or anyone), is there a quick way to estimate transaction cost? I thought I read somewhere that if a fund has 100% turnover a year (and turnover is available on Morningstar), then you could estimate the turnover cost as .50%. If turnover was 200%, the cost would be 1%. (I have forgotten where I read this.)

Thanks
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