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Mutual Fund Fees
Old 04-09-2013, 08:02 PM   #1
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Mutual Fund Fees

This question is prompted as a result of my former employer's change of administrator for their 401(k) and 457 plans. One of the drivers in the RFP was the fee structure... which got me to thiniking.

I know that funds have fees embedded. Duh. My question is this: Since "my" return on a fund is NET of the fees (after deducting them), why do I really care? Expecially if it is a "managed" fund. If a fund manager can produce a stellar return, net of the fees, wouldn't I be smart to go ahead and pop for the fees to get a great return? Or, if it is a fund managing to an index, and if it achieves that goal (say managing to the S&P 500) so that my return matches the S&P 500, again, why do I care? They did what they said (My return = Index). Why do I care how much they get paid?

Now when there is a different CLASS of funds (say "investor" vs. "institutional") and the underlying holdings are the same, then, yes, the institutional with its lower fees will provide a higher yield (or lower loss... lol). In that case, I can see where fees are important.

But between fund "x" and fund "Y" (same or different family), where the holdings are different, shouldn't the net return be more important than fees?

(b-t-w, the former employer switched to a provider that DID provide a different class of the existing funds - same holdings - and had lower fees. In that case, fees were important.)
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Old 04-09-2013, 08:25 PM   #2
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Sure one wants the highest performance for a given level of risk. If a fund manager has higher fees, but ends up with higher performance than the benchmark after fees, then it is very likely that the manager took on higher risk. This is especially true in bond funds where higher risk is easily discerned by the portfolio (longer duration bonds, riskier bonds).

I suppose you have seen that a good proxy for higher performance is lower fees. Higher fees generally map to lower performance. This all assumes the same level of risk.

There is also the Active vs Passive scorecard: Thought Leadership - SPIVA - S&P Dow Jones Indices
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Old 04-09-2013, 08:29 PM   #3
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My 403(b) is with Fidelity. Over the years, they have continued to lower fees on index funds to where they are lower than even Vanguard. Then, this year, my employer negotiated a fee return from Fidelity that netted me an average of 1/10th of a percent over the entire balance even though some of the funds fee is less than .07. I cannot complain about the fees I am paying.

Marc
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Old 04-09-2013, 08:29 PM   #4
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Here's an interesting article on fund performance & fees.

Reiterates the low probability of active funds outperforming index funds, then goes on to show how fees affect your return over time - even in those cases where you assume a higher return for the active funds. It also shows why the market hasn't caused active funds to go extinct - there is a small chance of beating index funds over time.

A New Way Of Calculating The Brutal Arithmetic Of Fund Fees - Forbes
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Old 04-09-2013, 09:13 PM   #5
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I'm happy to buy active funds, just as the OP notes.

However, expenses are a relentless headwind that the manager must constantly overcome just to break even. All pretty well discussed in active vs. passive debates.
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Old 04-09-2013, 09:18 PM   #6
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Originally Posted by AWeinel View Post
My question is this: Since "my" return on a fund is NET of the fees (after deducting them), why do I really care? Expecially if it is a "managed" fund. If a fund manager can produce a stellar return, net of the fees, wouldn't I be smart to go ahead and pop for the fees to get a great return?
And the hope/belief that a manager can outperform the market enough to make up for his fees is what keeps the whole segment of high-cost MFs in business. The problem is that you as a customer can't discern if a manager has outperformed the market due to luck, taking more risk, etc. The data set is just too noisy and you've got one data point. But we do know that when we look at bigger sets of data the chances of a manager outperforming over time are very small.
If someone offers me a chance to get paid 4:1 if I pick the next number to get rolled on a die, and if I take the bet and it pays off, do I still think it was a good bet? Or do I recognize that the real odds were 6:1 and it was a bad bet that just worked out that one time? Do I do it again and again?

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Or, if it is a fund managing to an index, and if it achieves that goal (say managing to the S&P 500) so that my return matches the S&P 500, again, why do I care? They did what they said (My return = Index). Why do I care how much they get paid?
In theoretical terms if all mangers truly just bought the securities in the index then they would all lag the index by exactly their expenses. In the real world managers can do some things around the edges (lend out securities, make a little money on the float, etc), but in general their costs are still very important. If a higher-cost fund (or ETF) beats a lower-cost index fund, it might be worth taking a peek under the hood to make sure you agree with the little "enhancements" they are using.
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Old 04-09-2013, 09:30 PM   #7
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I'm happy to buy active funds, just as the OP notes.
NO! I am really more into Index funds thru VG. When I (choke, choke) w*rked for a living, I pretty much had to buy managed funds - I was limited by teh offerings in the Plan. Now that I am thankfully ER'd, I have gone to one of the "set it and forget it" portfolios. And am very happy.

It was that prior experience and their recent change in plan administrators that even brought the question back to the fore.
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Old 04-10-2013, 05:04 AM   #8
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There is a reason why they have to say, "Past performance is no indicator of future returns." The reality is that most actively-managed funds fail to outperform their index. Someday, odds are, it'll be the actively-managed funds you have. The impact of expenses on actively-managed fund performance is well-documented elsewhere. There will always be folks who will insist that they can time the market, pick out which fund managers will have the magic touch that year, etc. It turns saving for retirement into a long-running Vegas trip. If you're game for the excitement of finding out whether your gambles will pay off in the end, I suppose the thrill of the suspense, itself, is part of the value you get.

If you are concerned about expenses, though, keep in mind that it is more than just what you see - even after the new disclosure requirements have gone into effect: Turnover hides a good amount of excess expense in actively-managed funds, and in index funds that are based on something other than market cap, as well. It take a lot of trading, with trading costs assessed on each trade, to pursue certain investment objectives. Those fees do not show up in the ER; they're hidden in the (lower-than-they-should-be) returns.
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Old 04-10-2013, 06:59 PM   #9
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NO! I am really more into Index funds thru VG. When I (choke, choke) w*rked for a living, I pretty much had to buy managed funds - I was limited by teh offerings in the Plan. Now that I am thankfully ER'd, I have gone to one of the "set it and forget it" portfolios. And am very happy.

It was that prior experience and their recent change in plan administrators that even brought the question back to the fore.
Sorry, not what it read like to me. But I was referring more to the reasoning described than your personal preference.

Morningstar lists 96 domestic large blend, distinct portfolio only, funds that have better performance than vfinx (Vanguard S&P 500 index) over the last 15 years. There are 199 funds with 15 year records, and 483 funds in the category. While an index fund is a safe choice that you know won't blowup way off the index, it's still kind of hard to justify picking the #97 fund after all fees have been accounted for.

Sure, some of those funds may have extra small cap or extra international exposure, but that is probably not a static allocation over the 15 years. So I don't really agree that you can duplicate performance (by yourself, statically) by using a set of comparable index funds and just holding them.

I'm only between about 5 and 10 years of holding my mutual funds, after switching from individual stocks but so far I've been happy with the performance of my active funds versus their comparable index funds. I do have 7 index funds (ETF's) for categories in which I didn't care for any of the active fund choices.
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Old 04-11-2013, 03:47 AM   #10
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Sorry, not what it read like to me. But I was referring more to the reasoning described than your personal preference.
Morningstar lists 96 domestic large blend, distinct portfolio only, funds that have better performance than vfinx (Vanguard S&P 500 index) over the last 15 years. There are 199 funds with 15 year records, and 483 funds in the category. While an index fund is a safe choice that you know won't blowup way off the index, it's still kind of hard to justify picking the #97 fund after all fees have been accounted for.
The problem with your logic is that you cannot go back in time fifteen years and put money into those other funds. And the past 15 years says too little (and references have already been provided to you regarding this) about which funds will be in that set of 97 fifteen years from now.

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Sure, some of those funds may have extra small cap or extra international exposure, but that is probably not a static allocation over the 15 years.
The point is that it is higher risk. You are essentially paying a higher price in terms of risk, to get the higher returns, and the chances that that fund that was in the top 96 during the last fifteen years dropping below during the next fifteen years is therefore higher.

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So I don't really agree that you can duplicate performance (by yourself, statically) by using a set of comparable index funds and just holding them.
Except that studies have shown this, on average. Unless you use 20/20 hindsight, i.e., have a time machine.
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Old 04-11-2013, 06:29 PM   #11
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...

Morningstar lists 96 domestic large blend, distinct portfolio only, funds that have better performance than vfinx (Vanguard S&P 500 index) over the last 15 years. There are 199 funds with 15 year records, and 483 funds in the category. While an index fund is a safe choice that you know won't blowup way off the index, it's still kind of hard to justify picking the #97 fund after all fees have been accounted for.
The morningstar list says nothing of the funds that have been liquidated or merged into other funds. This is common with low performing mutual funds. The effect is called survivor bias.
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Old 04-11-2013, 07:43 PM   #12
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Very few funds manage to beat the averages in a year. Fewer over three years, even fewer over 5 years.

Indexes Beat Active Funds Again in S&P Study - Forbes

There is no way to know that your manager will be one of the few who will consistently beat the market averages over a long period of time. OTOH, you can know with certainty that your fees are among the lowest.
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Old 04-11-2013, 08:44 PM   #13
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The morningstar list says nothing of the funds that have been liquidated or merged into other funds. This is common with low performing mutual funds. The effect is called survivor bias.
Yeah, that's why I added the total numbers of funds in there. How many funds do you think were alive 15 years ago and quit between then and now? I've seen a few M* reports that included numbers of defunct funds, and they are significant, but they'll still be a fraction of 199 I believe. So maybe VFINX is in the top 25%, including defunct funds? I couldn't find my favorite M* active/passive report, but it's on one of our other active/passive threads. They are starting to make more sense I think.
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Old 04-12-2013, 05:32 AM   #14
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How many funds do you think were alive 15 years ago and quit between then and now?
I seem to remember John Bogle outlining how many funds go defunct, generally, in one of his books. He highlighted the impact of "survivor bias".

Found it...
"During the past five years alone, an astonishing 28 percent of all general equity funds have gone out of business."

Bogle, John C. (2009-05-18). The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns (Little Books. Big Profits) (Kindle Location 1545). John Wiley and Sons. Kindle Edition.
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Old 04-12-2013, 06:50 AM   #15
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I seem to remember John Bogle outlining how many funds go defunct, generally, in one of his books. He highlighted the impact of "survivor bias".

Found it...
"During the past five years alone, an astonishing 28 percent of all general equity funds have gone out of business."
And many of them "merge" into other funds, usually to the detriment of the shareholders in them. If I have one beef with Vanguard it is they take underperforming funds and morph them into other ones........
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Old 04-12-2013, 11:02 AM   #16
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If I have one beef with Vanguard it is they take underperforming funds and morph them into other ones........
Isn't it better that they try to salvage investors' losses to some degree than to just leave them hanging in the wind?
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Old 05-09-2013, 11:05 AM   #17
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Related article:

How much does your money manager cost you? - May. 7, 2013
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Old 05-09-2013, 11:52 AM   #18
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Isn't it better that they try to salvage investors' losses to some degree than to just leave them hanging in the wind?
Depends. Does it result in significantly deviating away from the strategy defined in the prospectus? Does it result in excessive taxable activity that an investor would rather avoid? Does it result in higher fund expenses?
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Old 05-09-2013, 01:36 PM   #19
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Depends. Does it result in significantly deviating away from the strategy defined in the prospectus? Does it result in excessive taxable activity that an investor would rather avoid? Does it result in higher fund expenses?
In many cases, yes. VG has taken their dogs and merged them into other funds over the year. I am sure some are surprised that an index fund company would have "dogs". since alll they are doing is buying into an index, but it happens......
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