Mutual Funds: Information on Trends in Fees and Their Related Disclosure
Published: 2003-03-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Millions of U.S. households have invested in mutual funds whose value exceeds $6 trillion. The fees and other costs that these investors pay as part of owning mutual funds can significantly affect their investment returns. Recent press reports suggest that mutual fund fees have increased during the market downturn in the last few years. In addition, questions have been raised as to whether the disclosures of these fees and other costs, such as brokerage commissions, are sufficiently transparent. GAO updated its analysis from its June 2000 report, which showed the trends in mutual fund fees from 1990 and 1998 for large funds by collecting data on how these 76 funds' fees changed between 1998 to 2001. GAO also reviewed the Securities and Exchange Commission's recent rule proposal on fee disclosure as well as studies by industry.
section_title: What GAO Found
paragraphs: Recent data indicate that mutual fund fees may have increased. Studies by the staff of the Securities and Exchange Commission (SEC) and the Investment Company Institute found that expense ratios for mutual funds overall have increased since 1980. GAO's prior analysis of large mutual funds showed that these funds' average expense ratios generally decreased between 1990 and 1998, but between 1999 and 2001, the average ratio for the large stock funds analyzed has increased somewhat while the average ratio for the large bond funds has continued to decline. The average expense ratio for these large funds overall remains lower than their average in 1990. SEC is proposing that investors receive additional information about mutual fund fees in the semiannual reports sent to fund shareholders. If adopted, these new disclosures would appear to provide additional useful information to investors and would allow for fees to be compared across funds. However, various alternatives to the disclosures that SEC is proposing could provide information specific to each investor and in a more frequently distributed and relevant document to mutual fund shareholders--the quarterly account statement, which presents information on the actual number and value of each investor's shareholdings. Industry participants have raised concerns that requiring additional disclosures in quarterly statements would be costly and that the additional benefits to investors have not been quantified.

section_title: Letter
paragraphs: I appreciate the opportunity to provide information on GAO’s recent work  on mutual fund fees. Millions of U.S. households have invested in mutual  funds whose value exceeds $6 trillion. The fees and other costs that these  investors pay as part of owning mutual funds can significantly affect their  investment returns. Recent press reports suggest that mutual fund fees  have increased during the market downturn in the last few years. In  addition, questions have been raised as to whether the disclosures of these  fees and others costs, such as brokerage commissions, are sufficiently  transparent. In a report issued in June 2000, we found that fees for the  largest stock and bond mutual funds had declined from 1990 to 1998 but  that not all funds had reduced their fees. We also found that mutual funds  do not usually compete directly on the basis of their fees, and we  recommended that Securities and Exchange Commission (SEC) consider  additional disclosures regarding fees to increase investor awareness and  to encourage additional price competition among funds.
The operating costs that mutual funds incur are expressed as a percentage  of fund assets and called the fund’s operating expense ratio. This expense  ratio includes the management fee (the amount the fund’s investment  adviser charges for managing the fund), the fund’s other operating  expenses (such as fund accounting or mailing expenses), and 12b-1 fees  (distribution expenses paid out of fund assets). Moreover, funds incur  other costs not included in the expense ratio that also can affect investor  returns. For example, funds pay commissions to broker-dealers to execute  trades for their fund. This statement responds to your request that we (1)  provide updated information on how mutual fund fees have changed since  our June 2000 report, (2) discuss how fund fees are currently disclosed  and various alternatives for expanding these disclosures, and (3) provide  information on how mutual funds’ trading costs are disclosed.
To evaluate trends in mutual fund fees, we obtained and analyzed data on  the fees and other expenses of 76 mature stock and bond mutual funds  from financial research organizations to update analysis presented in our  June 2000 report. At the time we conducted the work for our June 2000  report, these were the largest funds in existence during the period 1990- 1998. Because these funds had grown more than other funds, we expected  them to have been subject to the greatest economies of scale, which could  have allowed their advisers to reduce the fees they charge investors. For  this statement, we obtained information on these funds’ assets, expenses,  and other information from 1999 to 2001, which was the latest year  complete data were available for all these funds. We also reviewed recent  studies by regulators and industry associations on trends in mutual fund  fees. To describe how fund fees are disclosed and various alternatives for  expanding these disclosures, we relied on our prior work on this subject;  also we reviewed current SEC rule proposals and comment letters by  industry participants and investors. To assess the brokerage commissions  mutual funds pay and how these are disclosed, we reviewed SEC rules and  studies by academics and others. For each of the topics we addressed in  this statement, we also gathered views and relevant documentation from  staff at SEC, three mutual fund companies, the Investment Company  Institute (ICI), which represents mutual fund companies, and an investor  advocate.
In summary, recent studies show that mutual fund fees may be on the rise.  Our prior analysis of large mutual funds showed that these funds average  expense ratios generally decreased between 1990 and 1998, but between  1999 and 2001, the average ratio for the large stock funds we analyzed has  increased somewhat while the average ratio for the large bond funds has  continued to decline. The average expense ratio for these 76 funds overall  fees remains lower than their average in 1990. However, since 1998, the  majority of stock and bond funds we analyzed had higher expense ratios in  2001 than they did in 1998. The decline in assets for many stock funds  since 2000 may have contributed to the recent increase in expense ratios  because many funds have fee schedules that decrease fees at various  increments as fund assets increase. However, when assets decline, less of  these funds’ assets are charged the lower fee increments, which increases  the expense ratio they report as a percentage of their total assets.  Although most of the expense ratios for the large bond funds we analyzed  had also increased, the overall average of these funds’ ratios had declined  because assets for lower-fee funds were growing faster than those of  higher-fee funds.
In response to the recommendation in our 2000 report that SEC consider  additional disclosures regarding fees, SEC issued proposed rule  amendments in December 2002 that would require that mutual funds make  additional disclosures of fees to their shareholders. These new disclosures  would appear to provide additional useful information to investors and  will allow for fees to be compared across funds. However, SEC is  proposing that this information be included only in the semiannual  shareholder reports, which provides information to all of a mutual fund’s  investors that is not investor specific. Various alternatives to the  disclosures that SEC is proposing were discussed in our prior reports and  those of others that could provide information specific to each investor in  a more frequently distributed and relevant document to mutual fund  shareholders—the quarterly account statement, which presents  information on the actual number and value of each investor’s  shareholdings. However, industry participants have raised concerns that  requiring additional disclosures in quarterly statements would be costly  and their additional benefits to investors have not been quantified.
Industry participants and others are also debating whether to increase the  disclosures that mutual funds are required to make about their trading  costs, such as the commissions funds pay to broker-dealers when they  trade securities. Currently, funds are required to disclose the amount of  brokerage commissions they paid only in reports sent to SEC, which are  available to investors only if specifically requested. Although SEC has not  proposed any changes to how funds disclose these costs, academics and  investor advocates believe that additional disclosures of these expenses  would be useful to investors. However, industry participants raised  concerns over whether such disclosures would provide information that  could be meaningfully compared across funds.
subsections: section_title: Mutual Fund Fees Appear to Have Risen Recently
paragraphs: Data from others and our own analysis indicates that mutual fund fees  may have increased recently. Studies by SEC and ICI found that expense  ratios for mutual funds overall have increased since 1980. Our own  analysis finds that average expense ratios for large stock funds have  increased since 1998, but those for large bond funds have declined since  then.
subsections: section_title: Recent Studies Indicate that Mutual Fund Expense Ratios Have Increased
paragraphs: Since we issued our report in 2000, the staff at SEC have published a study  of mutual fund fees that showed that fund expense ratios have increased.  The SEC staff study measured the mutual fund expense ratio of all stock  and bond mutual funds between 1979 and 1999. The study used a weighted  average of mutual funds in order to give more weight to funds with more  assets. Their study found that the average expense ratio for these funds  rose from 0.73 percent in 1979 to 0.94 percent in 1999. However, they  noted that the increase in mutual fund expense ratios since the 1970s can  be attributed primarily to changes in the manner that mutual funds and  their shareholders pay for distribution and marketing expenses. Over this  period, many funds have decreased or replaced front-end loads, which are  not included in a fund’s expense ratio with ongoing rule 12b-1 fees, which  are included in a fund’s expense ratio. Front-end loads are charged to  investors as a percentage of the initial investment when they buy shares  and are used to compensate financial professionals, such as the investor’s  broker or financial planner.
Using a different methodology, ICI also published a series of studies that  show that, although expense ratios may be rising, the overall cost of  investing in mutual funds has decreased. ICI’s studies attempt to measure  what it calls the “total shareholder cost” of investing in mutual funds by  considering both a fund’s operating expense ratio and any sales charges,  such as loads, investors paid when investing in that fund. To determine the  average total cost of investing in funds as a percentage of fund assets, ICI  also weights each individual fund’s total cost by the fund’s sales each year.  By using sales to weight each fund’s contribution to the overall average,  ICI indicates that it is attempting to present the cost and the actual  investment choices made by investors purchasing mutual fund shares in  particular years. In its latest study using this methodology, ICI reports that  the total shareholder costs for equity funds fell from 2.26 percent of fund  assets in 1980 to 1.28 percent in 2001, and that the total cost of investing in  bond funds declined from 1.53 percent to 0.90 percent during the same  period.
According to ICI’s study, the primary reason that the total cost of mutual  fund investing has declined results from the reduction in sales and other  distribution costs paid by mutual fund investors over this period. For  example, ICI finds that the average load has fallen from 7.0 percent of the  dollar value of investors’ purchases to 5.2 percent and sales of shares not  subject to such loads have also increased. For example, some funds waive  the load for certain investors, such as purchases by retirement plans.
Some industry participants have criticized the ICI’s methodology. As we  discussed in our June 2000 report, analysts at one industry research  organization acknowledged that the ICI data may indicate that the total  cost of investing in mutual funds has declined. However, they said that  because ICI weighted the fund fees and other charges by sale volumes, the  decline ICI reports results mostly from actions taken by investors rather  than advisers of mutual funds. These research organization officials noted  that ICI acknowledged in its study that about half of the decline in fund  costs resulted from investors increasingly purchasing shares in no-load  funds.
Although ICI’s study shows that the total cost of investing in funds may be  declining, it also shows that stock funds’ expense ratios have risen.  According to ICI’s September 2002 study, the average stock fund operating  expense ratio has risen from 0.77 percent in 1980 to 0.88 percent in 2001.  ICI’s study also shows that the average expense ratio of the stock funds it  reviewed has continued to rise in recent years from 0.83 in 1998 to 0.88  percent in 2001. ICI attributes this increase to two factors. First, funds  with higher expense ratios, such as aggressive growth funds or  international stock funds, have been popular lately and increased sales of  these funds would increase the overall average. Second, the decline in  assets experienced by many stock funds as a result of the market decline  since 2000 also means that such funds have fewer assets over which to  spread their fixed operating costs and thus their expense ratio would rise  as a percentage of their assets.
Recent press reports have also indicated that fees for mutual funds may be  increasing. For example, a March 2003 press report presented data from  Lipper, Inc., a mutual fund research service, that shows that the median  expense ratio for stock funds increased from 1.30 percent in 1998 to 1.46  percent in 2002.
section_title: Our Analysis Shows that Average Fees for Large Stock Funds Have Increased Recently, but Fees for Large Bond Funds Have Declined
paragraphs: Although our June 2000 report found that fees for large stock and bond  funds had generally declined between 1990 and 1998, analysis of recent  years shows that the average expense ratios for large stock funds have  risen since 1998 while fees for bond funds have continued to decline. For  our June 2000 report, we analyzed the change in expense ratios from 1990  to 1998 for 77 large stock and bond mutual funds, which because of their  growth during this period—which collectively averaged over 600  percent—were likely to have experienced economies of scale in their  operations that would allow them to reduce their expense ratios. To  calculate the average expense ratios on the large mutual funds identified  in our previous report, we weighted each fund’s expense ratio by its total  assets. The resulting asset-weighted average expense ratios represent the  fees an average investor would expect to pay on every $100 dollars  invested in these funds during this period. Since our 2000 report one of the  bond funds was liquidated, so our analysis for this statement presents  comparable results for 76 funds.
As shown in figure 1, since 1990, the average expense ratio charged by the  large stock funds we analyzed, after generally rising during the mid-1990s,  declined the second half of the 1990s and then began rising again. The  asset-weighted average expense ratio for these stock funds declined from  0.74 percent in 1990 to 0.70 percent in 2001. However, the average expense  ratio of these funds has increased recently by about 8 percent, from 0.65  percent in 1998 to 0.70 percent in 2001. The average expense ratios for the  large bond funds also generally declined between 1990 and 2001, from 0.62  percent to 0.54 percent. However, unlike the stock funds, the bond funds  have continued to decline since 1998.
Various factors may explain the recent rise in stock fund expense ratios.  ICI and industry participants attribute recent increases in average expense  ratios industrywide to asset declines among stock funds. For example, ICI  reported that total assets held by stock funds have declined from over   $4 trillion in 1999 to about $3.4 trillion at the end of 2001. The decline in  assets for many stock funds may have contributed to the recent increase in  expense ratios because many funds have fee schedules that charge lower  management fees at various increments as the fund’s assets increase. As  the assets of a fund with such a declining rate fee schedule increase, these  additional assets are assessed a lower-percentage rate fee, which results in  the fund reporting a lower total expense ratio overall. However, when  assets decline, more of the fund’s assets are charged the higher  management fee increments, resulting in an increase in the overall  expense ratio of the fund.
However, asset declines and resulting increases in some expense ratios do  not explain all of the increases in the average expense ratio for the large  stock funds we analyzed because the assets of most of these funds  continued to grow. Overall, the total assets in the 46 stock funds we  reviewed increased from $835 billion in 1998 to over $1,052 billion in 2001.  Individually, 28 of the 46 stock funds experienced asset growth between  1998 and 2001, although most of these funds’ assets declined from 2000 to  2001.
The decline in the average expense ratio for bond funds shown in figure 1  appeared to arise from stronger asset growth in lower-fee funds. We  divided the 30 bond funds in our analysis into two groups: (1) those funds  with expense ratios in 1998 that were higher than the 0.60 percent  weighted average ratio for all 30 funds and (2) those funds with expense  ratios in 1998 that were lower than the 0.60 percent weighted average ratio  for all 30 funds. As shown in table 1, the 16 low-fee funds experienced  overall asset growth of about 32 percent, whereas the assets of the 14 high- fee funds declined 16 percent from 1998 to 2001. In addition, the low-fee  funds’ average expense ratio declined by 7 percent whereas the high-fee  funds’ ratio decreased only 2 percent.
Looking specifically at the extent to which individual funds expense ratios  changed, we found that the expense ratios for the majority of the large  stock and bond funds we analyzed had also increased since 1998. As  shown in table 2, the expense ratios for 28 or 61 percent of the 46 large  stock funds we analyzed increased from 1998 to 2001. The table also  shows that half of these 28 funds had increased their total assets but their  expense ratios continued to increase. However the majority of these  expense ratios increases were less than 10 percent. Table 2 shows four  funds whose assets increased by more than 30 percent and whose expense  ratios increased by more than 10 percent. However, these four funds  management fees included provisions that would allow the fund adviser to  charge a higher rate if the fund’s performance exceeded certain  benchmarks. For example, the expense ratio of one of these funds  increased from under 0.60 percent in 1998 to 0.88 percent in 2001. This  increase is due in large part to the fund’s fee schedule, which calls for part  of the fund’s management fee to go up or down between 0.02 percent and  0.20 percent of assets annually, depending on whether the fund’s 3-year  performance was better or worse than the return of the S&P 500 index,  which this fund’s performance did exceed. Of the remaining 18 funds we  analyzed, most of whose assets increased, their expense ratios either did  not change or decreased between 1998 and 2001.
The expense ratios for the majority of bond funds that we analyzed also  increased. As shown in table 3, the expense ratios for 18, or 60 percent, of  the 30 large bond funds we analyzed also increased from 1998 to 2001.  Over this period, 14 of the funds’ assets decreased—which could increase  their expense ratios because less of their assets would be subject to lower  fee rates under a declining rate fee schedule. Four funds assets and  expense ratios increased between 1998 and 2001. However, of the 18 funds  with increased expense ratios, the majority of the increases were less than  10 percent.
section_title: SEC Is Proposing Additional Fee Disclosures, but Other Alternatives Could Provide More Specific Information
paragraphs: SEC is proposing that investors receive additional information about  mutual fund fees, but other alternatives for disclosing fees exist that could  better inform investors of the actual fees they are charged. The SEC  proposal would allow fees to be compared across funds, but would  present information to investors in dollar amounts using only illustrative  investment amounts. In contrast, various alternative means of providing  additional fee disclosures would provide dollar amounts calculated using  each investors’ own account balances or number of shares owned and  present this information in the quarterly statements they receive that show  the value of their mutual fund holdings. Although mutual funds generally  do not emphasize the level of their fees in their advertisements, SEC is  also proposing that additional disclosures be made in such materials.
subsections: section_title: SEC Proposal Provides Additional Information on Fees
paragraphs: Since 1988, SEC has required that mutual fund prospectuses include a  table that shows all fees and charges associated with a mutual fund  investment as a percentage of net assets. The fee table reflects (1) charges  paid directly by shareholders out of their investment such as front- and  back-end sales loads and (2) recurring charges deducted from fund assets  such as management and 12b-1 fees. The fee table is accompanied by a  numerical example that illustrates the aggregate expenses that investors  could expect to pay over time on a $10,000 investment if they received a 5- percent annual return and remained in the fund for 1, 3, 5, or 10 years. In  addition, SEC adopted requirements in January 2001 that require mutual  funds to disclose their after-tax returns. SEC staff told us that taxes can  have an even more significant impact on investors’ returns than fund  expenses.
In response to the recommendation in our 2000 report that SEC consider  additional disclosures regarding fees, SEC released proposed rule  amendments in December 2002 whose primary purpose is to require  mutual funds to disclose additional information about their portfolio  holdings, but also proposes that they make additional disclosures about  their expenses. Under this proposal, SEC would require that mutual fund  investors be provided with information on the dollar amount of fees paid  using preset investment amounts. This information would be presented to  investors in the annual and semiannual reports prepared by mutual funds.  Specifically, mutual funds would be required to present a table showing  the cost in dollars associated with an investment of $10,000 that earned  the fund’s actual return and incurred the fund’s actual expenses paid  during the period. This disclosure is intended to permit investors to  estimate the actual costs in dollars that they bore over the reporting period  using the actual return for the period. In addition, SEC is also proposing  that mutual funds present in the table the cost in dollars, based on the  fund’s actual expenses, of a $10,000 investment that earned a standardized  return of 5 percent. This second disclosure, would allow investors to more  easily compare the differences in the actual expenses of two funds  irrespective of any performance differences between the two.
SEC is also proposing that a narrative accompany these two new expense  disclosures. The narrative would explain that mutual funds have  transaction-based charges, such as loads or fees for exchanging shares of  one fund for another, and ongoing costs, as represented by the expense  ratio, and that the numerical examples are intended to help shareholders  understand these ongoing costs and to compare these costs with the  ongoing costs of investing in other mutual funds. The narrative would also  explain the assumptions used in the examples, note that the examples do  not reflect any of the transaction-based costs, and advise investors that  examples are useful in comparing ongoing but not total costs of investing  in different funds.
The method of disclosure that SEC is proposing is consistent with one of  the alternatives discussed in our June 2000 report. As SEC’s rule proposal  states, the two new expense figures being proposed are designed to  increase investor understanding of the fees that they pay on an ongoing  basis for investing in a fund. The proposed disclosure in shareholder  reports would supplement the fee disclosure required in the mutual fund  prospectus. According to SEC staff, the new disclosures they are  recommending would be placed in the annual and semiannual reports  because these documents contain more information than quarterly  statements and thus would allow investors to better understand fee  information in an appropriate context. SEC staff also believe that  providing this information in these reports will allow investors to compare  the fees of one fund to another. If adopted, we agree that the proposed  disclosures would provide investors with additional useful information.
SEC has received a wide range of comments on their proposal specific to  disclosure of fund expenses. Most comments were in support of SEC’s  requirement to include the dollar cost associated with a $10,000  investment. For example, one investment advisory firm commented in its  letter that the new disclosures SEC is proposing would benefit investors  by allowing them to estimate actual expenses and compare costs between  different funds in a meaningful way. Some commenters also noted that  requiring specific dollar disclosures was not necessary, given the potential  costs and burdens to mutual fund companies. One large labor union  supported SEC’s proposal, but encouraged SEC to explore cost-effective  methodologies to provide investors with their actual share of fees. An  industry association representing attorneys stated in its letter that it  generally supported the additional disclosures SEC was proposing, but  given existing disclosures requirements, the benefits of these additional  disclosures appeared marginal at best.
section_title: Alternative Disclosures Could Provide Investors More Specific Information
paragraphs: Alternatives to the SEC proposal could offer more investor-specific  information. While SEC’s proposed disclosures would provide additional  information that investors could use to compare fees across funds, the  disclosures in SEC’s 2002 proposed rule amendments would not be  investor specific because they would not use an investor’s individual  account balances or number of shares owned. In addition, SEC’s proposed  placement of these new disclosures in the semiannual shareholder reports,  instead of in quarterly statements, may be less likely to increase investor  awareness and improve price competition among mutual funds. Quarterly  statements, which show investors the number of shares owned and value  of their fund holdings, are generally considered to be of most interest to  investors.
In our June 2000 report, we offered another alternative for disclosing fee  information that would provide shareholders with the specific-dollar  amounts of fees paid on their shares in their quarterly account statements.  We noted that such disclosure would make mutual funds comparable to  other financial products and services such as bank checking accounts or  stock or bond transactions through broker-dealers. As our report noted,  such services actively compete on the basis of price. If mutual funds made  similar specific-dollar disclosures, we stated that additional competition  on the basis of price would likely result among funds.
SEC and industry officials raised concerns about requiring specific-dollar  disclosures in quarterly statements. They believed that the potential costs  associated with accounting for, and reporting, costs on an individual basis  could be significant. After our June 2000 report was issued, ICI  commissioned a study by a large accounting firm to survey mutual fund  companies about the costs of producing such disclosures. This study  obtained information from 39 mutual fund companies and entities that  provide services to mutual funds. To produce specific-dollar disclosures,  the respondents indicated the most costly activities that would be  necessary to produce this information included  enhancing current data processing systems    modifying investor communication systems and media    developing new policies and procedures and  implementing employee training and customer support programs.
Officials highlighted, in many cases, that mutual fund companies do not  have access to the name and account information for individual  shareholders to whom the fee disclosures would be made. Instead, broker- dealers or financial planners maintain account information on the many  shareholders who purchase their mutual fund shares through these third  parties. The third parties in turn maintain what are called omnibus  accounts at the mutual fund. As a result, the mutual fund will know only  the total number of shares owned by clients of a particular party, but not  know how many actual shareholders there are and how many shares each  shareholder owns. To disclose the specific-dollar amount of fees for each  of these shareholders would require funds and third parties to  communicate daily to receive the specific cost information that would  then have to be attributed to each shareholder’s individual account.
The ICI study concluded that the aggregated estimated costs of the survey  respondents to implement specific-dollar disclosures in shareholder  account statements would exceed $200 million, and the annual costs of  compliance would be about $66 million. However, this estimate did not  include the reportedly significant costs that would be borne by third-party  financial institutions, which maintain accounts on behalf of individual  mutual fund shareholders.
Although ICI’s estimates are significant in the aggregate, when spread over  the accounts of many investors, the amounts are less sizeable. For  example, ICI reported that at the end of 2001, a total of about 248 million  shareholder accounts existed. If the 39 fund companies, which represent  77 percent of industry assets, also maintain about the same percentage of  customer accounts, then the 39 companies would hold about 191 million  accounts. As a result, apportioning the estimated $200 million in initial  costs to these accounts would amount to about $1 per account.  Apportioning the estimated $66 million in costs to these accounts would  amount to $0.35 per account.
Another option to improve mutual fund fee disclosures would involve  calculating estimates of fund expenses attributable to individual investors.  One former fund adviser suggested that mutual funds could provide  investors with fairly precise estimates of what they are paying in fees in  their quarterly account statement by multiplying the funds’ expense ratio  for the prior year by the assets that the shareholder held as of the last day  of the year or period. According to the former fund adviser, this  calculation, which would help investors better understand the fees their  investments are incurring, could be made at minimum cost to mutual  funds.
According to some mutual fund officials, the expense calculation  disclosure presents similar cost concerns and raises other issues.  According to ICI staff, mutual funds and third-party financial institutions  may have to develop improved communication links to pass the  information needed to make this calculation, and thus would incur some  of the same costs as specific-dollar disclosures would entail. In addition,  mutual fund officials expressed concerns that providing investors  estimates could also create problems. For example, an estimate calculated  on the basis of the investor’s holding on the closing day of the statement  could be highly inaccurate if the number of shares owned by the investor  has changed dramatically during the period. ICI staff also noted that fund  complexes would likely want to include considerable explanatory material  or disclaimers about the nature of the estimated information that this type  of disclosure would provide. Before requiring mutual fund companies and  others to incur such costs to produce these additional disclosures, ICI  officials said that the benefits to investors would have to be better  quantified.
As a result, although additional disclosures could provide investor-specific  information and in documents that investors receive more frequently, fund  companies and other financial institutions would incur costs to produce  such additions to the existing reporting made to fund shareholders. The  benefit to investors from receiving this additional information has not  been quantified.
section_title: Mutual Fund Advertisements Usually Do Not Focus on Fees, but SEC Is Proposing Additional Disclosures
paragraphs: Although mutual fund officials say that funds compete vigorously against  each other, they generally do not emphasize fees in their advertisements  and SEC is proposing additional disclosures be made. In our 2000 report,  we reported that fund advisers generally do not emphasize the level of  their fees when attempting to differentiate their funds from those of their  competitors. We recently analyzed 29 different mutual fund  advertisements that ran in the 2002 and 2003 mutual fund editions of three  major business magazines. Of these, only three advertisements  emphasized low management fees, 12b-1 fees, or expense ratios. In  addition, while one mutual fund family, which accounted for 9 of the 29  advertisements, frequently advertised that its funds had no loads, the  primary emphasis in the majority of advertisements was on other themes  such as, in order of their frequency, the importance of long-term  investments, risk management, good performance as evidenced by high  rating by mutual fund advisory services, and tax savings.
In 2002, SEC proposed amendments to investment company advertising  rules. These changes would allow mutual funds to advertise more timely  information than that appearing in fund prospectuses and would require  more balanced disclosure of information, particularly in the area of past  performance. The proposal also includes a provision that would require  funds to indicate that information about charges and fees can be found in  a fund’s prospectus. Under current requirements, mutual funds are not  required to discuss fees in advertisements. Nevertheless, in practice, most  of the mutual fund advertisements that we analyzed already included  language that referred investors to the fund prospectus for information on  fees and charges.
section_title: Mutual Fund Trading Costs Are Additional Expense to Investors but Are Not Prominently Disclosed
paragraphs: In addition to the expenses reflected in the expense ratio, mutual funds  also incur trading costs that also affect investors’ returns. Among these  costs are brokerage commissions that funds pay to broker-dealers when  they trade securities on a fund’s behalf. Currently brokerage commissions  are not routinely or explicitly disclosed to investors and there have been  increasing calls for disclosure as well as debate on the benefits and costs  of added transparency.
subsections: section_title: Brokerage Commissions Add to Investor Costs
paragraphs: When mutual funds buy or sell securities for the fund, they may have to  pay the broker-dealers that execute these trades a commission. In other  cases, trades are not subject to explicit brokerage commissions but rather  to markups or spreads. For example, the broker-dealers offering the  stocks traded on NASDAQ are often compensated by the spread between  the buying and selling prices of the securities they offer. Other trading- related costs that mutual funds can incur include potential market impact  or other costs that can arise when funds seek to trade large amounts of  particular securities. For example, a fund seeking to buy a large block of a  particular company’s stock may end up paying higher prices to acquire all  the shares it seeks because its transaction volume causes the stock price  to rise while its trades are being executed.
Data from mutual funds indicates that brokerage commissions and other  trading costs can be significant. Estimates of the size of brokerage  commissions mutual funds pay ranged from 0.15 percent of funds’ assets  to as much as 0.50 percent. Various academic studies conducted in the  mid-1990s found that brokerage commissions were around 0.30 percent of  a mutual fund’s total assets. For example, a study that looked at more  than 1,100 stock and bond funds found that brokerage commissions for  these funds averaged 0.31 percent of fund assets. These studies also  found that brokerage commissions increase as turnover—the extent to  which the fund buys and sells securities—increases.
In some cases, a portion of the brokerage commissions that funds pay may  represent payment for research services from the executing broker-dealer.  When a portion of the commission entitles the fund to such research, this  amount is called “soft dollars.” One academic study estimated that mutual  funds pay brokerage commissions of about $0.06 per share traded.  Because individual investors trading through discount broker-dealers can  trade for as little as $0.02 per share, the study’s author attributes the  higher amount of commissions—about 66 percent of the total amount per  share—paid by mutual funds to charges for soft dollar research. Fund  managers are allowed to engage in this practice under a provision created  by the Congress in Section 28 (e) of the Securities Exchange Act of 1934.  In adopting this section, the Congress acknowledged the important service  broker-dealers provide by producing and distributing investment research  to fund managers and permitted fund managers to use commission dollars  paid by managed accounts to acquire research. SEC staff told the authors  of this study that funds that obtain research using soft dollars would have  the opportunity to reduce their expense ratios because the fund’s manager  is not incurring as many direct costs for research activities. However, this  study, which looked at 240 stock funds, also found that the funds with  higher expense ratios also had higher brokerage commission costs. The  authors said that this could either mean that these funds are investing in  stocks that are more costly to research and to trade or that the managers  of these funds were less resolute about reducing their expense ratios even  though they did not have to pay directly for some of the research services  obtained for their funds.
section_title: Calls Made for Increased Disclosure of Brokerage Commissions
paragraphs: Brokerage commissions are not disclosed in documents routinely sent to  investors, and some parties have called for additional disclosures.  Currently, SEC requires mutual funds to disclose the amount of brokerage  commissions paid in the statement of additional information (SAI), which  also includes disclosures relating to fund policies, officers and directors,  and tax matters. Specifically, SEC requires funds to disclose in their SAI  how transactions in portfolio securities are conducted; how brokers are  selected; and how they determine the overall reasonableness of brokerage  commissions. Unlike fund prospectuses or annual reports, SAIs do not  have to be sent periodically to a fund’s shareholders, but instead are filed  with SEC annually and are sent to investors upon request. The amount  disclosed in the SAI does not include other trading costs borne by mutual  funds such as spreads or the market impact cost of the fund’s trading. SEC  staff told us that, although investors are not sent the disclosures on  brokerage commissions unless they request it, funds are required to  disclose their portfolio turnover in their prospectuses, which new and  existing investors are routinely sent.
Academics and other officials have called for increased disclosures  relating to mutual fund brokerage commissions and other trading costs. In  the academic studies we reviewed that looked at brokerage commission  costs, the authors often urged that investors pay increased attention to  such costs. For example, one study noted that investors seeking to choose  their funds on the basis of expenses should also consider reviewing  trading costs as relevant information. The authors of another study note  that research shows that all expenses can reduce returns so attention  should be paid to fund trading costs, including brokerage commissions,  and that these costs should not be relegated to being disclosed only in  mutual funds’ SAIs.
Others who advocated additional disclosure of brokerage commissions  cited other benefits. Some officials have called for mutual funds to be  required to include their trading costs, including brokerage commissions,  in their expense ratios or as separate disclosures in the same documents in  which they disclose their expense ratios. For example, one investor  advocate noted that if funds were required to disclose brokerage  commissions in these ways, funds would likely seek to reduce such  expenses and investors would be better off because the costs of such  funds would be similarly reduced. He also indicated that when funds are  required to disclose information, competition among funds usually results  in them attempting to improve their performance in the area subject to the  disclosures. He explained that this could result in funds experiencing less  turnover, which could also benefit investors as some studies have found  that high-turnover funds tend to have lower returns than lower-turnover  funds.