Investor Learning and Mutual Fund Advertising and Distribution Fees

Abstract

Barber, Odean, and Zheng’s [2005] analysis of mutual fund front-end loads, sales commissions, and operating expenses finds that over the past several decades ordinary investors have “learned” what they value in choice of funds. And, fund advisers learned early on to provide what attracts ordinary investors to particular funds: larger advertising.

While advertising now represents only 2% of 12b-1 fees, it remains large enough in absolute terms to be effective in attracting ordinary investors and increasing fund flow. The resulting growth in fund asset size has benefited advisers with additional economies of scale and larger dollar receipts of operating expenses, including management fees and 12b-1 fees. Fund shareholders thus pay major asset and performance penalties by giving such little consideration to fund operating expenses, especially component 12b-1 fees.

Distribution fees, a major category of the New Total Expense Ratio, are the focus. Distribution fees include 1) selling group payments of a) dealer (broker) concessions and b) account servicing fees; 2) revenue-sharing payments net of adviser fall-out benefits that include a) broker marketing pools, b) broker (bonus) compensation, c) syndicated distributions, d) sub-transfer agency fees, and e) networking fees; and 3) soft-dollar trades net of rebates to advisers.

Mutual fund distribution fees have major agency conflicts with fund shareholder assets and performance. Fund adviser/distributors should be prohibited from using fund assets to make distributor fee payments to brokers. Brokers should include any of what are currently called broker (dealer) concessions, account servicing fees, and component revenue sharing payments they wish to impose as one-time upfront charges at time of investor share purchase. Further, fund adviser revenue-sharing payments and soft-dollar trades should be prohibited by regulation.

Keywords: mutual funds, front-end loads, sales commissions, operating expenses, advertising, 12b-1 fees, ordinary investirs, fund flow, management fees, economies of scale, distribution fees, brokers, New Total Expense ratio, agency conflicts, revenue sharing, soft dollars, fund adviser

JEL Classification: G2, G23, G28