The Year's Biggest Fee Cuts and Hikes

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.

 Fidelity Dividend Growth (FDGFX) cut expenses by 0.29% to 0.62%, but we recently lowered the fund to Neutral because of a manager change.

A little more enticing is  Fidelity Mid-Cap Stock (FMCSX), which we rate Bronze. The fund's fees fell to a low 0.63% from 0.85%. The fund lagged the S&P Mid Cap slightly over the three years ended Oct. 31, 2013, but manager John Roth is modestly ahead of the benchmark since he took over in 2011. More important, he's nearly doubled the benchmark in seven and a half years at  Fidelity New Millennium (FMILX). Roth is a savvy growth manager who is seen as a rising star at Fidelity. He works closely with Will Danoff and was named a comanager with Danoff on  Fidelity Advisor New Insights (FNIAX). This is a good example of a fund where the manager's record is much better than the fund's. Usually such funds take a good while to get investors' notice.

Now we make our way to the first Silver-rated fund to have a big fee cut.  Perkins Small Cap Value (JSCVX) is closed to new investors, but its expense ratio cut to 0.84% from 1.04% ought to entice shareholders to stick around. The fund has weak short-term performance and strong long-term performance. "Given the fund's emphasis on downside protection, it's not too surprising that it's had a hard time keeping up in a rising market," writes our Perkins analyst Katie Reichart. 

 Fidelity Large Cap Stock (FLCSX) is another appealing fund. We raised it to Silver in July because we've been impressed by Matt Fruhan's process and performance. The fund's 18-basis-point expense ratio cut to 0.84% makes it all the more enticing. 

Skipping down a few notches, there are a couple of other noteworthy fee cuts at Silver-rated funds. The just closed  Artisan Global Value (ARTGX) has lowered fees to 1.37% from 1.50%. This is not a case of performance fees but one of rising assets due to great performance. It's definitely a keeper, and it illustrates how different it is to consider a fund with a performance-driven fee cut versus one with asset growth behind the fee cut. Generally, asset growth follows performance, so buying a fund like this one is an act of following performance and the crowd, whereas funds with performance-fee cuts are mostly contrarian plays where you have to tolerate middling to poor short-term returns. 

 RiverPark/Wedgewood (RWGFX) had two great years out of the gate and that led to some nice inflows and a fee cut to 1.14% from 1.25%. It's not super cheap but is going in the right direction for a still fairly small fund. Although the fund is fairly young, we rate it Silver because David Rolfe has a great long-term record in a separate account version of this strategy. It's definitely worth a look. 

Rising Fees 
Get out your rotten tomatoes for these funds' fee hikes. Well, not really, because some of these funds still charge a modest amount. And the biggest fee hike comes from a fund we rate Gold. 

 Vanguard Convertible Securities'  expense ratio rose to 0.63% from 0.52% because of a performance fee, but the fund is still the cheapest in its category. 

 Fidelity Spartan International Index  raised fees to 0.20% from 0.11%, annoyingly letting the fee waiver expire, but it remains the cheapest option for individual investors and thus is rated Silver. 

However, there are three Neutral-rated funds in which fees rose. I would be less inclined to hold on to these funds.  Fidelity International Small Cap's (FISMX) expense ratio rose to 1.31% from 1.22% because of the impact of performance fees. On top of that, the fund just changed managers. The firm is moving management from a foreign affiliate back to FMR Co. As of Feb. 28, it is run by Sam Chamovitz with support from a completely different slate. In sum, it is a bit pricier and now is a blank slate on the management side. 

 Fidelity Growth Discovery (FDSVX) and  Thornburg Value (TVAFX) raised expenses by 0.07% and 0.08%, respectively, and both are rated Neutral.

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