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The Mutual Fund Industry

The Mutual Fund Industry: Competition and Investor Welfare

R. Glenn Hubbard
Michael F. Koehn
Stanley I. Ornstein
Marc Van Audenrode
Jimmy Royer
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  • Book Info
    The Mutual Fund Industry
    Book Description:

    Mutual funds form the bedrock of retirement savings in the United States, and, considering their rapid growth, are sure to be more critical in the future. Because the size of fees paid by investors to mutual fund advisers can strongly affect the return on investment, these fees have become a contentious issue in Congress and the courts, with many arguing that investment advisers grow rich at the expense of investors.

    This ground-breaking book not only conceptualizes a new economic model of the mutual fund industry, but also uses this model to test for price competition between investment advisers, evaluating the assertion that market forces fail to protect investors' returns from excessive fees. Highly experienced authors track the growth of the industry over the past twenty-five years and present arguments and evidence both for and against theories of adviser malfeasance. The authors review the regulatory history of mutual fund fees and summarize leading case decisions addressing excessive fees.

    Revealing the extent to which the governance structure of mutual funds truly impacts fund performance, this book provides the best understanding of today's mutual fund industry and is a vital tool for investors, money managers, fund directors, securities lawyers, economists, and anyone concerned with the regulation of mutual funds.

    eISBN: 978-0-231-52532-9
    Subjects: Law, Business, Finance

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-x)
  3. List of Figures
    (pp. xi-xii)
  4. List Of Tables
    (pp. xiii-xvi)
  5. Foreword
    (pp. xvii-xx)

    Mutual funds are the primary vehicle used by individuals to invest in the stock and bond markets, and they are the overwhelming choice in retirement plans. Thus, the effectiveness of 401(k), individual retirement account (IRA), and other savings plans depends upon the efficiency and the competitiveness of the mutual fund industry. If individuals are disadvantaged by anticompetitive practices in the industry and by excessive fees, the quality of life for millions of retirees will be compromised. Small wonder that the fees charged by the industry have come under close scrutiny, and the industry has attracted more than its share of...

  6. Preface
    (pp. xxi-xxiv)
  7. Introduction
    (pp. 1-10)

    The benefits to consumers from competition are most apparent when competition is absent. As an example, there is a story told of men’s shoe manufacturing during the 1950s in the Soviet Union.¹ Under the Soviet central planning authority, several plants manufactured identical style men’s black shoes. Each plant was assigned a production quota, and each plant met its quota. There remained, however, a manufacturing problem that the central planners had not solved—the shoes tended to fall apart within a short time period. A young planner offered a bright idea—identify each pair of shoes by the plant of origin....

  8. CHAPTER ONE Mutual Fund Industry Growth and Importance in Retirement Plans
    (pp. 11-17)

    The mutual fund industry experienced slow, steady growth from approximately 1940 to 1980. Since then, the absolute amount of dollars invested in mutual funds has grown significantly. The number of house holds in the United States that owned mutual funds rose from approximately 4.5 million in 1980 to 50.4 million in 2007, or from 6 percent of total house holds in 1980 to approximately 44 percent in 2007.¹ Net new money flow into mutual funds totaled $5.0 trillion from 1990 to 2007. As shown in Table 1.1, total net assets under management grew via asset appreciation and new money investment...

  9. CHAPTER TWO Mutual Funds and Charges of Excessive Fees: The Historical Background
    (pp. 18-29)

    As noted, since the 1960s a number of mutual fund industry studies have concluded that investment advisers fail to compete on price, resulting in excessive fees and, importantly, artiicially low returns to investors.¹ Many studies end with forceful conclusions of market failure in the mutual fund industry, accompanied by strong, critical views of investment advisers as well as the Securities and Exchange Commission (SEC) for not correcting the problem. No less than the chief investment oficer of Yale University and the Yale Endowment concluded that mutual fund investors are abused by investment advisers in the form of"outrageous fees excessive trading,...

  10. CHAPTER THREE Mutual Fund Excessive Fees and the Courts
    (pp. 30-47)

    Outside the legislative process, the courts have grappled for decades with the question of whether mutual fund fees are excessive. In Gartenberg, the leading decision in this area from 1982 to the present, the District Court for the Southern District of New York found that the defendant, Merrill Lynch, did not charge excessive fees and that it faced effective price competition from rival money market funds.¹ On appeal, the Second Circuit Court of Appeals rejected the district court’s opinion that price competition existed among money market mutual funds, but found in favor of Merrill Lynch due to shortcomings in the...

  11. CHAPTER FOUR Price Competition and the Demand for Mutual Funds
    (pp. 48-80)

    Up to this point we have recounted the growth of mutual funds in the United States, the development of laws and regulations established over the last several decades that were designed to prevent the imposition of excessive fees on investors, discussed opposing district and appellate court opinions on how to judge fees and whether fees are set by competition, and presented the arguments advanced by fee critics for why current laws and regulations have failed to adequately protect investors from excessive fees. We now address directly the question of price competition and excessive fees by testing for the extent of...

  12. CHAPTER FIVE Mutual Fund Industry Structure and Indicators of Price Competition
    (pp. 81-98)

    As discussed in Chapter 3, the 1982 Gartenberg decision relied on the 1966 conclusion of the Securities and Exchange Commission (SEC) that equity mutual funds do not compete on price. Similarly, Congressional debates from 1968 to 1970 concerning proposed legislation to guard against excessive mutual fund investor fees, leading to the addition of Section 36(b) to the ICA of 1940, relied on the same SEC conclusion of no price competition. The 1982 Gartenberg guidelines for investigating excessive fee cases are still applied, over 40 years after the SEC concluded that mutual funds do not compete on price.¹

    Just as mutual...

  13. CHAPTER SIX Mutual Fund Pricing, Excessive Fees, and Empirical Evidence
    (pp. 99-129)

    Studies concluding that retail mutual fund investors pay excessive fees generally base their claim on one or some combination of three observations: (1) Retail fund investors pay substantially higher management fees than institutional investors; (2) retail investor fees vary widely across competing mutual funds; and (3) economies of scale, which produce declining unit costs in mutual fund operations, are not closely related to trends in average fund expense ratios. Fee critics contend that management fees are lower in the institutional sector because investment advisers compete vigorously on price to gain institutional clients, whereas retail investors incur higher fees because retail...

  14. CHAPTER SEVEN Mutual Funds’ Organizational Form and Conflicts of Interest
    (pp. 130-149)

    As described earlier, fee critics claim that the organizational structure of most mutual funds, with investment advisers and mutual funds operating under separate ownership, necessarily creates a conlict of interest over the level of fees and, with bargaining power favoring investment advisers, represents the root cause of excessive fees.¹ Some critics also imply that mutual fund directors are bought off by advisers to approve excessive fund shareholder fees.²

    Proposals to resolve the excessive fee problem center on reducing the postulated conflict of interest between fund shareholders and investment advisers. Two proposals are commonly offered. One proposal calls for eliminating the...

  15. CHAPTER EIGHT What Have We Learned?
    (pp. 150-158)

    Studies by the Securities and Exchange Commission (SEC) on competition in the 1960s mutual fund industry concluded that fund investment advisers did not compete on price, resulting in years of overcharges to investors. This conclusion has informed the law and regulations directed at mutual fund pricing from 1970 to the present, resulting in numerous lawsuits charging investment advisers with breaching their fiduciary duty to investors and imposing excessive fees on fund shareholders.

    We have examined the nature of competition in the mutual fund industry, with speciic attention to retail equity mutual funds. We sought to determine whether current industry conditions...

  16. Appendix to Chapter Four
    (pp. 159-182)
  17. Appendix to Chapter Seven
    (pp. 183-186)
  18. Notes
    (pp. 187-212)
  19. Bibliography
    (pp. 213-220)
  20. Index
    (pp. 221-228)