Roanoke Times
                 Copyright (c) 1995, Landmark Communications, Inc.

DATE: MONDAY, August 16, 1993                   TAG: 9308140009
SECTION: MONEY                    PAGE: A-8   EDITION: METRO 
SOURCE: JERRY MORGAN NEWSDAY
DATELINE:                                 LENGTH: Medium

FUNDS' FEES DON'T ALWAYS FALL WITH GROWTH

It's a nice theory, but a rare practice.

In the past three years, from June 29, 1990, to this June 30, more than $800 billion flooded into mutual funds, bringing the total to $1.8 trillion. Compare that to the $241 billion in all funds in 1981.

But from 1981 to 1992, the chunk of assets taken from investors to pay for the funds' overhead jumped from an average of 1.03 percent annually to 1.47 percent for all stock-oriented mutual funds. That difference in the so-called total expense ratio seems tiny, but each one-hundredth of a percent is worth big bucks to the fund's sponsor - $100,000 for every $1 billion in fund assets.

Why does it matter to investors? Simply, the higher the fee, the lower the fund's total return, because fees come off the top. For some, the issue also is a matter of principle: Shareholders are supposed to be owners of the mutual fund and should get the advantage of economies that come with increased revenue from increased size.

Some big fund operators, including Janus, Vanguard and American Funds, have dropped their fees accordingly. But those that haven't counter that there are costs that increase when you attract more shareholders, so fees can't go down. And some simply dismiss the issue altogether. If the fund's performance is good, they reason, who cares about fees?

The cost of running a fund that has grown large is theoretically offset by economies of scale - it costs less per customer to do business as more come in because some fixed expenses remain constant. A fund, for instance, may not need to hire more research analysts or do more advertising just because assets rise.

"There are certain costs that do not go up pro rata with assets. If the infrastructure is there, the next $100 million should not cost more," said Jack Thompson, executive vice president of the Janus Funds in Denver. Like some fund families, Janus builds in "break points" to its fee structure so that management fees are automatically reduced when assets top certain levels.

The issue casts a particularly harsh light on one kind of fee, known as the 12b-1 fee, which was supposed to help reduce costs for shareholders in the long run but has turned out to be just another drain on their return.

Like management fees, the 12b-1 is deducted from total assets each year. It is supposed to pay for advertising and distribution.

"The theory was that you add a small fee for distribution and advertise heavily," said Gerald Perritt, who writes The Mutual Fund Letter from Chicago. "That would attract a lot of shareholders who would pay a prorated share of fund expenses, so that expenses would go down. That hasn't happened. The competition for investor dollars has caused fees to go up."

Not all funds seek high fees. For some, such as the Vanguard Group in Valley Forge, Pa., the lowest possible fee is holy writ. "If we benefit from cash flow and a rising market, we ought to share some of that with the shareholders. It costs a fund nothing when good performance creates an increase in asset size," said John Brennan, president of Vanguard. The group is the lowest-cost mutual fund operation in the country and is among those that have required their investment advisers to reduce their fees.

But growth is expensive, argued Charles Dornbush, chief financial officer for Fidelity Mutual Funds in Boston. Fidelity's fund assets have doubled in three years to more than $200 billion. The giant Magellan fund alone went from $14 billion to $27 billion. "You have to service more customers as the funds grow, and you don't get economies there. We have nearly doubled the number of people in service."

The Denver-based Janus Fund, which has 1.8 million shareholders, dropped its management fee four basis points - 0.04 percent - over three years as it grew to $8.1 billion from $1.2 billion in 1990. That saves each shareholder an average of less than $2 a year, but costs Janus $3.2 million in lost fees.