Funds from Fidelity and Janus highlight the list of expense ratio hikes and cuts.
The article was published in the March 2014 issue of Morningstar FundInvestor.Download a complimentary copy of Morningstar FundInvestor here.
It's time to check your fees. Fund companies are updating expense ratios, and you'll want to take a close look at your fund fees to see how they've changed. At this writing many if not most funds have updated expense ratios through 2013. Because 2013 was a great year for stocks, quite a few equity funds are reporting lower fees. Many bond funds had small losses or small gains, and therefore we're seeing fewer changes.
It's worth watching because it means some funds are better bets and others face a higher hurdle in delivering outperformance and healthy yields. The annual report expense ratio is the one that you see most often. It tells you what the fund charged over the previous fiscal year, typically ending in October of the prior year. You may also see the prospectus net expense ratio, which tells you what the fund was charging when the prospectus was printed rather than what the actual fee hurdle was over the past 12 months. I tend to go by whichever one was published more recently, though there is one other difference of note. A prospectus net expense ratio also includes the cost of shorting stocks, and it rolls up the fees from any other mutual funds held in the portfolio so that you get an all-in cost. Neither is common in most funds, but it does matter when you are looking at a fund of funds or one that has significant sums in short positions.
What Drives Expense Ratio Changes
Most expense ratio changes are not a result of a fund company and a fund board agreeing on a new policy. Rather, the underlying fee structure isn't changed; it's just that there are changes designed into the structure. Asset changes are the biggest driver. A larger asset base leads to lower fees and a shrinking one to higher fees. That's because fund management fees often contain breakpoints that pass along some economies of scale to shareholders so that additional money over certain asset levels is charged a lower fee. For example, a fund might charge 0.80% on the first $1 billion, and then 0.75% on money between $1 and $5 billion, and 0.70% on money above $5 billion. Thus, as the fund's asset base moves above and below those triggers, its expense ratio will rise and fall. In addition, there are usually some additional but small fee cuts passed on to shareholders when a fund company grows because it can cut a better deal with service providers.
Most funds don't have performance fees, but the ones that do can see some big shifts. Performance fees reward or punish a fund company for performance relative to a benchmark, typically over three years. The pendulum must swing equally in both directions, and it must reflect returns after expenses. For example, Fidelity Contrafund FCNTX has a management fee of 0.56%, and that fee is adjusted up or down by a maximum of 20 basis points depending on whether the fund beat the S&P 500 over the trailing 36-month period. Right now, it is slightly ahead of the S&P 500, so it gets a small performance fee boost to raise it to 0.66%--still a pretty low fee.
I like performance fees because they align a fund company's interests with shareholders' and they give the company a good incentive to not charge too much. However, Vanguard, Fidelity, and Janus are about the only big firms with performance fees. Vanguard's performance fees tend to have a tighter band than Janus' or Fidelity's but of course they begin from a lower base fee.
The Biggest Fee Cuts
So, where are the bargains? Twelve of the 13 biggest expense ratio drops in the Morningstar 500 are Janus and Fidelity funds. (Perkins is part of the Janus family.) The largest of all comes from Fidelity Small Cap Stock FSLCX where lousy three-year returns prompted a 41-basis-point fee cut to 0.69%. We rate the fund Bronze despite the weak recent returns. Manager Lionel Harris took over in November 2011, so not all the underperformance falls at his doorstep. In addition, Harris produced strong results in a six-year run at Fidelity Small Cap Growth FCPGX.
Janus Global Research JAWWX is the beneficiary of a 30-basis-point cut to an 0.81% expense ratio--that's quite low for a world-stock fund. The fund cuts out the portfolio manager and hands the reins directly to Janus' foreign equity analysts. The fund went from a great three-year return ended in 2011 to a middling one that's still better than the MSCI EAFE. Thus, the pendulum has swung back to near a neutral position. The fund is now in the cheapest quintile for world-stock funds and earns a Bronze rating.