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Schwab Slashes Index Fund Fees

Plus, Reserve Primary Fund founder charged with fraud, and more.

Morningstar Analysts, 05/11/2009

Morningstar's fund analysts cover 2,000 mutual funds. Their full analyst reports, including Stewardship Grades, are available in Morningstar Principia Mutual Funds Advanced and Morningstar Advisor Workstation Office Edition.

In a move to attract more investors, Schwab announced that it has reduced the expense ratios of its six equity index funds. The firm also lowered its investment minimum to $100 and will charge the same fee to all investors, regardless of share class or investment amount.

The change directly challenges low-cost leaders Fidelity and Vanguard, fund families known for their cheap index funds. For example, the expense ratio of Schwab S&P 500 Index SWPIX, which dropped to 0.09% from 0.36%, is lower than the Vanguard 500 Index VFINX (0.15% with a $3,000 minimum investment) and Fidelity Spartan 500 Index FSMKX (0.10% with a $10,000 minimum). Schwab also cut fees on several of its actively managed equity and bond funds, including Schwab Hedged Equity SWHEX and Schwab Premier Equity SWPNX. All changes took effect May 5, 2009.

Schwab's push to lower costs comes at a time when many funds are seeing their expense ratios rise as net assets have fallen, either as a result of market depreciation or shareholder redemptions. Vanguard, for instance, recently announced small increases in expense ratios.

The firm is also likely targeting investors who might otherwise opt for cheap exchange-traded funds, like iShares S&P 500 IVV, which charges the same 0.09% expense ratio as Schwab S&P 500 Index.

Reserve Primary Fund Faces Fraud Charges
The SEC has charged Bruce Bent and his son, Bruce Bent II, with fraud for misleading investors of the troubled Reserve Primary Fund. The money market fund came under intense pressure in September 2008 when Lehman Brothers collapsed and its $785 million stake in Lehman's commercial paper--about 1.2% of the fund's assets--became worthless. As concerned investors pulled money out of the fund, it ended up "breaking the buck," or dipping below a net asset value of $1 per share--long a hallmark of money-market funds. The suit claims that the fund's founder, Bruce Bent, and co-chief executive officer, Bruce Bent II, didn't adequately disclose information about the fund's position in Lehman Brothers and falsely assured investors that its net asset value wouldn't drop below $1. The fund's manager, Reserve Management Company, was also named in the suit.

This isn't the first lawsuit brought against the Bents and Reserve Management Co. There are nearly 30 outstanding cases pending from disgruntled investors, and the commonwealth of Massachusetts has also filed charges. While most of the fund's assets have been distributed to shareholders, about $3.5 billion has been retained for legal defense. The SEC's suit seeks to have all of the fund's remaining money returned to shareholders.

Marriages of Convenience
John Hancock has proposed merging the $31 million large-value fund John Hancock Classic Value II JHVAX into $51 million JHancock3 Disciplined Value JVLAX. Classic Value II, subadvised by Pzena Investment Management, struggled in 2008 as some bad financial calls led to a loss of nearly 48% for the year. The fairly young fund, which launched in mid-2006, has also come under pressure following 20 consecutive months of outflows. Disciplined Value, subadvised by Robeco Boston Partners, fared better and has produced strong long-term results.

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