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ICI Defends Fund Fees versus Pension Fees

WASHINGTON - The fees at pension funds and mutual funds are virtually identical once the two entities are compared as "apples and apples" and include sub-accounts, an Investment Company Institute economist said during a conference call last Tuesday.

The mutual fund industry's top lobby group released a report that ripped into a 2001 study published in Iowa's Journal of Corporation Law. That earlier report contended that pension funds fees were strikingly lower than those of mutual funds.

Essentially, the ICI compared the fees of mutual fund sub-accounts with fees of public pension funds. If broken down into investment advisory fees, fees of small and medium-sized fund portfolios are lower than those of public pension funds, the ICI said. Larger fund portfolios average slightly higher in basis points than pension funds, 31-to-28, a disparity that ICI President Matt Fink characterized as minimal.

Apparent flaws in the Iowa report, published in 2001 and titled "Mutual Fund Advisory Fees: The Cost of Conflicts of Interest," including a lack of understanding that there are significantly more mutual fund accounts and varied balances within those accounts, were countered with a bevy of evidence by main author Sean Collins, a senior economist at the ICI.

Retail accounts also require a more hands-on approach than institutional accounts, according to the industry's trade group. Fees at pension plans cover only the selection and monitoring of investments, while much of the other work is contracted out to third parties.

But Collins' report argues at mutual funds, the advisory fee pays for fund managers to, among other things: allocate assets, set up 24-hour-per-day staff, prepare account statements and prospectuses and compile tax information.

Even New York Attorney General Eliot Spitzer recently cited the Iowa study as part of his tireless effort to drive fund fees down. Fink said Spitzer's reliance on the report was a chief reason the ICI conducted its own study.

Surprise Uppercuts

But during the conference call reserved for the media, two noteworthy voices piped up, none other than the Iowa paper's co-authors John Freeman and Stewart Brown. And the argument began.

Freeman took control, angering Fink and prompting him to repeatedly say, "This [conference call] is for the media." But Freeman stuck around and threw some uppercuts. Citing Alliance Capital's recent settlement with Spitzer (see MME 12/22/03), Freeman said it was concrete proof that fund fees were too high.

"What would account for them giving up a third of a billion dollars of profits over the next five years if they're not overcharging?" Freeman asked. He did not receive an answer.

To its credit, the ICI did not include the figures of Vanguard in its study, which would have lowered the numbers even more.

Brown, the other co-author of the Iowa report, argued that his report did include Vanguard and still showed a huge disparity between pension and mutual fund fees. He also stressed that in the 2001 report, he and Freeman intentionally did not include the administrative fees associated with mutual funds.

Spitzer Weighs In

Spitzer was not silent after the report was released, either. He told one New York paper that since only 20% of mutual funds are sub-advised, his running argument against mutual fund fees just received more empirical evidence.

"I love the ICI report. It proves my case," Spitzer said.

But what Collins' research would argue is that even accounts that are not sub-advised have manageable fees.

In its report, which it issued in conjunction with the call, the ICI said "this suggest that funds at mutual funds without sub-advisors generally incur similar costs as funds with sub-advisors for the selection and oversight of portfolio securities."

Collins said the reason for the similar costs between sub-advised and non-sub-advised funds is simple: Mutual funds shop around for better prices on services. If something can be done cheaper in-house, a fund does it in-house. And if a third party can do it cheaper, then the third party does the work.

In these scandal-tainted times, Collins' admissions prompted one reporter to question whether he was saying mutual funds were always concerned about the bottom line. Candidly, Collins replied, "Yes."

Puzzlingly, while Collins' report stated that the fees of sub-accounts are roughly the same as non-sub-accounts, during the conference call he said, "We have not compared the management fees of sub-advised funds with the management fees of non-sub-advised funds."

So, it seems that despite the research, people like Spitzer will continue to try and drive down mutual fund fees. That the report itself might be used in Spitzer's favor is the most unlikely and troublesome result for the ICI.

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