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Thursday, May 30, 2013

Is Burt Malkiel Wrong?

News summary by MFWire's editors

Have asset managers "entirely captured" the economies of scale that have accompanied the fund industry's boom over the past 30 years? That is what famed economist Burton G. Malkiel contends in an opinion piece published today in the Wall Street Journal.

For background, Malkiel is today the chief investment officer at Wealthfront, but he is better known as the author of A Random Walk Down Wall Street and one of the original table pounders for passive investing. Not only did he inspire Jack Bogle, he served as a Vanguard director for 28 years.

It is no surprise then, that Malkiel writes that today's investors are paying too much in fees:
There is another way of looking at these asset-management fees. Total fund assets increased 135 times since 1980, but the total expenses paid to equity mutual-fund managers increased 141 times (to $24,143 billion from $170.8 million).
Malkiel concedes that a one percent fee sounds low, but that that fee translates into one seventh of equity market returns and "well over half of dividend distributions."

Slicing the data another way, Malkiel writes that annual expense ratios for actively managed funds rose to 91 basis points from 66 basis points between 1980 and 2010. He also points out that institutional management fees have not fallen over that time (nor have the risen).

So, fees for retail funds are up even as the asset base over which they are charged has rapidly expanded. So why do so many fund firm CEOs lament squeezed margins?

Malkiel does not mention another major change in the industry since 1980: how distribution is paid for. In 1980 funds were either sold by a full-commission broker or directly to shareholders.

Soon thereafter the SEC allowed the first 12b-1 fees and by the 1990s there was an explosion in share classes, most of which were about finding a different way to compensate the salesman.

Today, fund supermarkets levy a typical fee of 40 basis points for mutual funds sold off their shelves along with various and other platform fees. In exchange, the shareholders gets to avoid explicit commissions.

That shift means that distribution fees that were once separate are now part of the fund expense ratio. Interestingly enough, the changes in average expense ratios for actively managed mutual funds cited by Malkiel have increased in proportion to typical distribution costs.

The second point made by Malkiel, that the expanding AUM in held in mutual funds should have led to lower expense ratios is a more compelling one.

Of course, Malkiel also sings the praises of indexed funds and ETFs:

However, index funds and their exchange-traded counterparts have allowed the individual investor to benefit from scale economies. Exchange-traded funds that track the Standard & Poor's 500 Stock Index or the Wilshire 5,000 Total Stock-Market Index are available to individual investors at expense ratios of five basis points or less.

If every story should leave the reader wanting more, Malkiel offers this:

Why do investors continue to pay such high fees for financial services of such questionable value? Many may incorrectly judge the quality of investment advice by the price charged. Individual and institutional investors may suffer from overconfidence and truly believe that they can select the best investment managers and earn excess returns, despite historical evidence to the contrary.

That is an interesting question to be answered another day.

For Malkiel's full thoughts, check out the original article here

Edited by: Sean Hanna, Editor in Chief


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