Johnsen on Mutual Fund Fees: Proxy for Quality Assurance?

A Fiduciary News article cites Professor D. Bruce Johnsen's research examining whether it makes sense to focus on fees in investing.

Johnsen's paper "Myths About Mutual Fund Fees: Economic Insights on Jones v. Harris," forthcoming in the Journal of Corporation Law, uses economic theory to argue that fees are irrelevant as a first approximation and that investors may view fees as a proxy for quality assurance.

"The more difficult it is for investors to monitor and assess management quality, the higher the fee necessary to assure quality. By paying the manager a premium fee, investors assure that the adviser has more to lose in the long run by deceptively lowering quality." Johnsen says.

The Department of Labor's draft Investment Advice Rule cautions that investment advice should emphasize fees over past performance but does not distinguish between negotiable and non-negotiable fees, prompting concern that the government may be legislating to ignore other qualitative measures for investing.

401k Fees That Shouldn't Matter, Fiduciary News, May 3, 2010. By Chris Carosa.

"So where does that leave us in determining the difference between those fees that really matter (direct fees) and those fees that shouldn’t matter (indirect fees)? Academics may argue to varying degrees, but regulators will have the final say. Unfortunately, different definitions of fees only confound the ERISA fiduciary.

"Service providers charge direct fees (called a 'management fee' by the plan’s investment adviser) over and above any mutual fund expense ratio. The DOL adds to the confusion by calling a portion of the fund’s expense ratio a 'management fee' (the other portion is called 'other fees'). Although technically correct from the point of view of the Investment Company Act of 1940, the confusion arises when one considers the direct management fee mentioned above. The fund’s expense ratio is similar to the expenses of a publicly traded company. They aren’t fees paid by the shareholders of the fund, they represent expenses paid by the fund to conduct its business. For publicly traded companies, investors look past performance (primarily through earnings). Likewise, it appears that for mutual funds, investors may place greater weight on past performance, despite what the SEC desires."

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