How much is too much? That’s the question at the center of a highly contentious debate over mutual fund fees. And, except in extreme cases (for instance, the recently liquidated Frontier Microcap Fund’s expense ratio at one point reached a mindboggling 18 percent, cementing its reputation as the mascot for absurdly high fees), the answer is far from clear.
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In fact, much of the time, the difference between reasonable and unreasonable annual fees is just a few tenths of a percentage point. While there’s no clear formula for determining when investors should write a fund off as too expensive, there are some issues worth considering. The most important is: Are the returns worth the expenses?
After all, subpar performance coupled with high fees is perhaps the best reason of any to dump a fund. Jeff Tjornehoj, Lipper’s research manager for the United States and Canada, notes that the case becomes even more compelling when a fund has underperformed year after year. “At that point, you can say it wasn’t just bad luck,” he says.
Here are five popular funds, each of which has at least $150 million under management, where the fees and the performance figures just don’t add up. All expense ratios are from funds’ annual reports.
ING Emerging Countries (NECAX). In 2007, this fund underperformed its Morningstar category (diversified emerging markets) by nearly 20 percent, only to follow up that awful year with a crushing 56.8 percent loss in 2008. To be sure, it bounced back by nearly 70 percent in 2009, but even that seemingly blockbuster figure landed it in the bottom half of its category for the year. As a result, its 2.04 percent expense ratio, which doesn’t compare favorably with the 1.72 percent average in its category, appears to be out of synch with its returns.
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State Farm S&P 500 Index (SNPAX). This S&P 500 index fund has an expense ratio of 0.79 percent. While this may not seem high at first blush, the fees are exorbitant when compared to the host of other S&P 500 exchange-traded funds and mutual funds that offer the same services for a fraction of the cost. Take, for instance, Schwab’s S&P 500 Index Fund, which charges just 0.09 percent per year. “To charge more than 50 basis points when there are all these other options out there is really unjustifiable,” says Morningstar analyst Ryan Leggio.
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Calvert World Values International Equity (CWVGX). This fund’s trailing 3-, 5-, 10-, and 15-year returns all land it in the bottom 5 percent of Morningstar’s foreign large value category. Despite this underperformance, it has an expense ratio of 1.86 percent, which is quite a bit higher than its category average of 1.38 percent.
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Morgan Stanley U.S. Government Securities (USGAX). Government securities aren’t exactly known for high yields. That’s why this fund’s expense ratio, which sits at 0.91 percent, can be a significant drag on the returns that investors are actually able to pocket. Overall, the fund is in the bottom 10 percent of Morningstar’s intermediate-term government bond category for the trailing 10-year period.
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Invesco Constellation (CSTGX). This large growth fund’s expense ratio of 1.42 percent is only a tad bit higher than its category average, which is 1.30 percent. Still, there are two factors to consider. First is the fund’s size: It has roughly $3 billion under management, meaning that it should be able to take advantage of economies of scale to keep a lid on prices. Beyond that, its 15-year trailing returns put it in the bottom 10 percent of its category.
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