Very High-Cost Mutual Funds and ETFs (Along With Cheaper Alternatives)

Barry from TX posted over 2 years ago:

Charles, this article may appear to many as just a regurgitation of something all AAIIers already know: mutual funds are much more expensive than ETFs. What may not be widely known is that this article is very timely and very important for mutual fund and ETF investors. Your good friend Jason Zweig – the other “Intelligent Investor-- must be channeling/communicating with you. In his WSJ column today (2/9/24), Jason explains how Vanguard patented the idea of ETFs as a share class alongside a mutual fund in 2005 and that patent expired in 2023. Since then, many large mutual funds providers (“the usual suspects”) filed requests with the SEC and have been approved to create ETF share classes for their existing MFs and several others are preparing similar requests. ETF share classes allow mutual fund providers to add an ETF share class onto an existing mutual funds as an identical portfolio. Here is the non-subscriber “gift link” to today’s Zweig article https://www.wsj.com/finance/investing/your-MF-stinks-can-this-wall-street-invention-change-that-73e86075?st=y2j760m1a9zvpx0&reflink=desktopwebshare_permalink and an earlier article on this topic https://www.wsj.com/articles/SB10001424127887324624404578255940811549604. PS. Just for sentimentalists, Ella Fitgerald’s signature song “How High the Moon?” would have been a good follow-up to your second question, “How high?, to develop your 1950’s leitmotif. I am guessing your choice of Doris Day was driven by an analogy to these funds as being dogs. Any additional information you can provide on ETF share classes inside mutual funds would be appreciated.

Gareth from MN posted over 2 years ago:

I am not familiar with all of the funds mentioned. Though I do not currently own it, I have been interested in BIZD in the past. BIZD is a fund of funds, and my understanding is that by regulation they are required to count in their fees and expenses the fees and expenses of the acquired funds BIZD holds. Thus, the 11.17% expense ratio in the article is terribly misleading because it is not a direct charge (or reduction of yield) to the shareholder. The yield after taking into account the expenses was 10.81% as of close Feb. 8. Why should one care what the expense ratio is if one can receive a 10%+ yield after expenses? BIZD's actual management fee is 0.4% (4/10th of a percent) which is more pertinent, while the acquired funds fees and expenses make up the difference. Because the author doesn't address this for BIZD (that the relevant fee appears to be 0.4%) and other so-called high-fee funds that are similar, and that the reported expense ratio doesn't reduce the effective yield, I have to question the credibility of the article and the conclusion that BIZD and others are expensive. If I were to invest in BIZD, would my total return differ materially than if I were to invest in the portfolio of funds embedded in BIZD? Their top 3 holdings comprising about 45% of their portfolio are ARCC, FSK and OBDC. As an individual investor, I don't believe I could do better that those who do it for a living. At the same time, while I might be comfortable with some of their picks, I might not be as enthralled with some of the not-so-good ones. Is the 0.4% management worth my not having to manage the multiple funds? I think that is a small price to pay for someone else managing the complexities of investing in multiple funds. They are also much more effective than I could ever be in using leverage to enhance long-term results.

Gareth from Minnesota posted over 2 years ago:

To say a little more, the point the author appears to be making is absolutely correct; that management fees, even small percentages, can eat up a significant amount of investment returns, especially over time with the compounding effect. If one's financial advisor charges "only" 1% of one's assets under management (the way the advisor would typically characterize it), I would suggest looking at it differently. If one were to expect an average annual return of 8%, the advisor's fee is actually 12.5% (1% divided by 8%) of the expected return. The principle espoused in the article is sound. However, it appears to be misapplied, at the very least in part, in the examples given.