Channel Anger At Wall St. Pay, Not Fund Fees

Americans are outraged over bloated executive pay - and rightly so. When a Richard Fuld (Lehman Bros.), Stanley O'Neal (Merrill Lynch) or Chuck Prince (Citigroup) rakes in millions of dollars from a firm spiraling downward, employees, shareholders and lawmakers have every reason to question how public corporations are governed.

The distinguished Judge Richard Posner of the 7th Circuit Court of Appeals nailed the problem when he wrote last year: "Executive compensation in large publicly traded firms often is excessive because of the feeble incentives of boards of directors to police compensation."

But what does this have to do with mutual funds?

The answer: Nothing. While corporate shareholders watched more and more of their potential dividends flow to top executives, fees and expenses that mutual fund investors pay fell by about 60% over the last three decades.

And while some irresponsible corporate boards fueled a cycle of can-you-top-this CEO pay packages, independent mutual fund directors were scrutinizing the performance, costs, and competitiveness of fund advisers, driving better deals for the shareholders they represent.

Unfortunately, Judge Posner chose to unleash his anger in an opinion he wrote on Jones v. Harris Associates LP. At issue in Jones: the legal standards used to weigh whether a mutual fund's advisory fees are excessive. Posner's comments were manna from heaven for trial lawyers, who are eager to turn unfounded allegations about fund fees into a steady stream of lucrative lawsuits.

So as Jones moves to the Supreme Court, with arguments scheduled for next Monday, Nov. 2, the plaintiffs bar gloats whenever gullible commentators use this case to hammer on padded paychecks.

The real story of mutual fund fees is far different.

The fund industry is virtually a textbook case of a competitive market. More than 8,000 mutual funds vie daily for the dollars of cost-conscious investors. If investors are happy with the price, performance, and service of their fund, they stay and invest more. If not, they walk - because it only takes a couple phone calls or a few clicks of the mouse to move to another fund.

There's plenty of evidence that investors do just that: In any given year, 25% to 70% of mutual fund advisers experience net outflows.

Funds have no choice but to compete, because investors have ready access to a wealth of information on every fund - and all of its competitors. Investors can mine a rich vein of fund data on fund Web sites, investing Web sites, and easy-to-use rating services like Morningstar and Lipper.

And those investors are checking fees: In the 10 years to 2008, every net new dollar invested in stock funds went into funds with below-average fees.

Competition and disclosure are backed up by a tough regulatory regime, with independent directors standing as the investors' first line of defense. A fund adviser's contract - including fees - must be approved every year by the fund's independent directors.

These directors spend months reviewing reams of information about the adviser's performance, services, costs and more. They have to be thorough, because they're required by the Securities and Exchange Commission to document their decisions.

An efficient market, combined with effective regulation, produces results. The 2009 Morningstar global mutual fund survey, measuring the experiences of investors in 16 countries in North America, Europe and Asia, gave U.S. funds an A - the highest grade in any of the countries measured.

The study found that U.S. mutual funds have the lowest annual expense ratio, with most investors in America paying less than 0.75% of assets for fixed-income funds and less than 1% for equity funds.

Sharp competition, strict oversight and tight regulation - that doesn't sound much like the mess in executive compensation, does it? Nor does the result - investors paying half as much per dollar of assets invested as in 1980.

Shareholders, watchdogs, lawmakers - and, yes, judges - have every right to be mad about CEOs' bloated pay. But don't use that issue to destroy a mutual fund market that is delivering results for millions of Americans.