Are You Paying More for Lower Returns? (Ticked Off)

Published March 6, 2009 at 5:00 a.m.

You’d think that mutual fund companies, struggling with investors yanking their money out after months of abysmal returns, would maybe cut them a break. But no, the current strategy is more akin to pouring salt on an open wound. Investors aghast over their funds’ poor performance may be in for another shocker on their next statement: higher fees. Thousands of fund companies increased fees last year in an attempt to cover the costs of running their funds, and analysts expect more to follow in 2009.

Perhaps most notably, Fidelity’s flagship Magellan Fund (FMAGX) increased its expense ratio by 36% in 2008, to 72 basis points from 53 basis points — the difference between a $72 fee and a $53 fee on a $10,000 investment. Fidelity isn’t alone, though. Putnam Diversified Income fund’s (PDVRX) expense ratio ticked up to 1.29% from 1.23% on some of its share classes.

For many funds, the fee increases aren’t a result of new thinking. Instead, the so-called “breakpoints” built into the funds’ fee schedules — which help investors by lowering fees when the funds’ assets rise — are working in reverse by increasing fees when the funds' asset levels fall off significantly. Indeed, expense ratios for more than 5,000 of the roughly 20,000 mutual funds on the market went up last year, mostly because of precipitous drops in asset levels, says Morningstar analyst Andy Gogarty. Expenses for American Century’s International Discovery fund (TWEGX) rose 11% due to falling assets, according to its most recent annual report, to 1.52% from 1.37%, while its International Growth fund (TWIEX) rose to 1.40% from 1.31%. American Century says the funds didn’t actively change the fees; the increases were "mathematical," and the firm sent out a letter to inform investors.

Smaller and newer mutual funds are the most likely candidates to increase fees after asset levels fall, since the funds' costs are spread across fewer investors. But don’t be too quick to scrap a fund solely because of slight fee increases. If you think the fund’s strategy is going to outperform others over time, a marginal fee increase "shouldn’t turn you away," says Gogarty.

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