Violations of the Law of One Fee in the Mutual Fund Industry

Abstract:     
In competitive markets, similar products should have similar prices. We apply this concept to mutual funds. We examine the residuals from regressions of fees (annual expenses and 12b-1 fees) on important fund characteristics, essentially allowing us to compare the fees of “identical” funds. We present striking new evidence of systematic differences in residual fees across all US equity funds. We find that the average spread in residual fees across funds over the sample is approximately 2.3%. The dispersion in fees has not decreased over time, despite the fact that significant numbers of new funds have entered and the aggregate amount of assets under management has increased substantially. An investor purchasing similar lower fee funds would have outperformed an investor purchasing higher fee funds by approximately 32% over our sample. We test a number of hypotheses to explain our results including a random fee, competition, service, captive investor, and strategic fee setting hypothesis, and are able to explain only a small portion of the spread in residual fees. Surprisingly, a main determinant of fees is the initial fee set by a fund, which varies little over time. Overall, our evidence is largely inconsistent with a competitive market for mutual funds.

Number of Pages in PDF File: 64

Keywords: Mutual Funds, Fund Fees, Price Dispersion, Price Persistence

JEL Classification: G10, G11, G23

working papers series