SEC Considers Cracking Down on Index Fund Fees

February 12, 2004

Exorbitantly high index fund fees have long been an open secret in the mutual fund industry. Now an invigorated SEC wants to have a say.

San Francisco-February 12, 2004. It's about time!

The SEC is looking into the bloated fees of many stock index funds, according to published reports in USA Today, the LA Times, and Morningstar.

Many index funds tied to the S&P 500, for example, are notoriously overpriced.  Vanguard's expense ratio is razor thin at 0.18% for its flagship Vanguard 500 index fund (VFINX), while Barclays Global Investors manages an ETF, iShares S&P 500 (IVV), that has a microscopic expense ratio at 0.09%.  However, Scudder and Morgan Stanley manage S&P index funds that charge as much as a whopping 1.50%.  Some B shares also charge hefty broker commission fees.  For example, the B share class of the Morgan Stanley S&P 500 index fund (SPIBX) has a 1.50% expense ratio.

"The onus is on the fund firms to explain why they're charging so much for these services," said Morningstar analyst Jeff Ptak.  "When you're talking about indexing, there are several advantages, but the two main ones are diversification and low cost advantage.  If you're parking an investors in an S&P 500 index fund and charging an expense ratio of 1.50%, then how can you possibly argue that you're not doing your investors a disservice.  Any cost advantage that was there is long gone at 150 basis points a year, so you've essentially guaranteed mediocrity, if not inferiority."

The SEC is also reportedly looking into research soft dollars and index funds.  Theoretically, index funds do not require extensive research resources because they track benchmarks.

"What's significant here is that this move may telegraph in some sense where the SEC is heading on the question of mutual fund fees," said Ptak.  "Overpriced index funds are a stark example of too high fees in the industry.  You would expect fierce price competition in a commodity-like area like index funds, but unfortunately that hasn't prevailed since there's considerable divergence in expense ratios." will cover this story as it develops.

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