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Mutual funds and their unfair fees – the feeling’s not mutual!

|Includes: The Charles Schwab Corporation (SCHW)

 It comes at no surprise to anyone at kaChing that the US Supreme Court is taking a close look at the fairness of fees that tens of millions of US households have been paying out to Mutual Funds. Retail investors have long been victim to a host of hidden fees from Actively Managed Mutual Funds and have never been able to command the level of access, transparency, or lower fees afforded institutional investors. At kaChing we believe it is high time that the playing field be leveled. We believe in radical transparency, in democratizing access to investing talent, and in putting an end to the industry’s double standard and hidden fees. To quote the lead attorney, David Frederick, who according to the WSJ, “argued before the court that fund firms charge investors in their mutual funds twice what they charge institutions even though they use ‘the same manager to provide the same research analytics from the same research group, from the same meetings, buying the same stocks, and simply allocating them to different accounts.’” This practice has gone on too long. Since our founding two years ago, it’s a complaint that we have heard many times from investors who are frustrated with their Mutual Fund experience. The primary causes for their frustration are:

· Lack of transparency
· Poor rating system to determine if managers are lucky or skilled
· Large and primarily hidden fees

It’s difficult in these short news briefs on the Mutual Fund legal battles to really understand why and how Mutual Funds manage to charge so much in fees for retail investors. As with kaChing, most retail investors of mutual funds are only familiar with being charged a standard management fee based on assets under management. Often this fee is as low as 0.5 – 0.7%, which leads most retail investors to believe they aren’t being charged much to have their money managed. Sounds like quite a deal! But what most retail investors don’t realize is that the management fee is just the beginning when it comes to Mutual Funds. There are a whole host of additional fees buried in legal documents that few people ever read. We think it’s time to shed some light on the dark world of Mutual Fund hidden fees. Here are the top 5 hidden fees most retail investors don’t realize they are being charged. You might be surprised by what you find, but we assure you all our assertions are correct.


1) Marketing fees: Mutual Funds are allowed to expense all their marketing fees back to their funds, so as an investor you are paying the Mutual Funds to market to you! Have you ever heard of another business that is allowed to do this? This type of fee is known as a12b-1 fee and it often as large as the management fee. Under NASD regulations, investment advisors can charge up to 1% of assets under management for 12b-1 fees.

2) Recommendation fees: Mutual Funds also pay brokerage firms to recommend their funds. You know how brokers like Charles Schwab make recommendations as to which Mutual Fund you should buy? Well, that recommendation is usually based on which Mutual Fund pays them the most. Schwab earns the majority of their revenues from Mutual Fund referral fees. Again, you, not the Mutual Fund, pay the fee.

3) “Load” or “Exit” fees: A Load fee is equivalent to a commission you pay in order to buy the Mutual Fund. This is not to be confused with the commission the Mutual Fund manager pays to buy and sell stocks in your Mutual Fund portfolio. An Exit fee is the commission you pay to sell your stake in the Mutual Fund. Funds that charge a high Load tend to have low Exit fees and vice versa. Funds that have high Loads have low 12b-1 fees and vice versa. You can be sure that one way or the other the Mutual Fund will charge you to invest in their fund even if they claim no Load.

4) Tax liability: The most hidden of all the fees associated with Mutual Funds is the undisclosed potential tax liability. Imagine you invested in a Mutual Fund on July 1st at which time the Fund had an unrealized gain of $100 million (which you would not know because it is never disclosed). Let’s further assume that the value of the fund did not change for the rest of the year, but the manager realized the gains created before you invested. Believe it or not, you are on the hook for your proportionate share (based on your ownership in the mutual Fund) of those gains even though you were not an investor when those gains were created. That’s absurd, but it’s part of the tax laws.

5) Soft dollars: The most unseemly fee associated with Mutual Funds is known as “soft dollars.” This is not a fee charged by a fund, but rather another case of the Mutual Fund pushing a fee that in every other business would be borne by the vendor onto the client. Here’s how it works. Imagine you were an investor looking to set up a new Mutual Fund. You would approach your institutional broker and ask for office space, telecommunications services, computers, research and other help in return for paying a higher commission than would be charged if you didn’t receive their help. These extra commissions can significantly impact the performance of your Mutual Fund. In his book “Unconventional Success,” acclaimed investment manager and Yale University Chief Investment Officer David Swensen analyzed data from Lipper Inc., a global leader in supplying mutual fund information, and determined that the average Mutual Fund pays 0.2% of assets under management in the form of commissions. An extra commission of only $0.02 per share due to “soft dollar” reimbursement represents at least an additional 0.2% reduction in your Mutual Fund’s performance.

Ultimately, add up all these extra fees and expenses and you’re looking at paying at least 3% of assets under management. Over the long term it has been shown by Robert D. Arnott, Andrew D. Berkin and Jia Ye in their article titled “How well have taxable investors been served in the 1980s and 1990s?” in the Journal of Portfolio Management that on average Mutual Funds generate a return equal to the market rate of return less their fees. Paying 3% sure explains why consumers are so frustrated by their Mutual Fund investments.

For a more detailed explanation of all the inappropriate fees charged by Mutual Funds, we suggest you read Unconventional Success written by David Swensen, the incredibly successful Chief Investment Officer of the Yale Endowment.

Retail investors deserve better, and with the technology available to us – there is no excuse for keeping investors in the dark. On kaChing, the only fee you pay is the management fee disclosed on the Genius’s portfolio page. There are no marketing fees, sales loads or exit fees, undisclosed tax liabilities or soft dollar expenses. Everything is disclosed because of our philosophy of radical transparency.Fees alone should not be the basis of how you choose an investment manager, but an almost 2% difference between the average fee charged by kaChing and the total fees and expenses associated with Mutual Funds is hard to ignore.


Disclosure: No positions