Are Mutual Fund Investment Advisory Fees Determined Competitively?

Abstract:     
Investment advisors hold mutual funds captive, despite creating and managing them, giving rise to a conflict of interest. Prior research demonstrated that open end mutual funds overcharge customers by about 25 basis points annually for standard services as compared to similar services provided to public pension funds with no conflicts of interest. This overcharging yields about $27.5 billion in excess fees annually.

The Investment Company Institute sponsored research that argued that investment advisory fees are determined competitively due to relatively free entry and large numbers of buyers and sellers of mutual funds. That research argued that competitively determined fees cannot be excessive.

A hallmark of competitive industries is that they earn normal profits and normal rates of return for their shareholders. Using the Fama-French methodology, this paper demonstrates that fund sponsors have earned very high and statistically significant excess returns for their shareholders over the last 25 years and subsequent shorter periods. In 1985, a $100 investment in a capitalization weighted index of fund sponsors would have been worth in excess of $21,000 by the end of 2009, while a similar investment in S&P 500 stocks would have been worth only about $1,200 over the same time period. The paper concludes that fund sponsors have systematically violated fiduciary standards.

Number of Pages in PDF File: 33

Keywords: Mutual Fund Fees

JEL Classification: G12, G14, G18, G23

working papers series