SEC Investor Group: Mutual Funds and ETFs Should Provide Better Cost Disclosures
That most retail investors choose to outsource their investing decisions and activities to professionals at mutual funds and exchange-traded funds (ETFs) has created some dilemmas for the US Securities and Exchange Commission (SEC). Its recent concept release on business and financial disclosures reveals one strand of this dilemma, specifically to whom those disclosures are directed. More relevant to retail investors, however, is the matter of disclosures of mutual fund costs, an issue raised by the SEC Investor Advisory Committee (IAC) at its most recent meeting this month.
The issue of the costs of investment products, and retail investors’ understanding of those costs, helped motivate the recently released best-interest rules from the US Department of Labor. In that instance, the primary concerns related to the costs of variable annuities and the billions in foregone retirement savings for retail investors.
Kurt Schacht, JD, CFA, managing director of Standards and Advocacy at CFA Institute, who serves as IAC chairman, said, “The committee’s concern relates to investment fund costs that, over time, can consume a significant portion of an investment’s returns.”
He pointed to a report CFA Institute published, Packaged Retail Investment Products: Investor Disclosure Considerations for a Key Information Document, and in particular, to charts found on pages 17 and 18 that show graphically the negative effects costs can have on investment returns over time. Even a 1% annual fee can consume more than 30% of investors’ returns over 40 years. Double the fee, and the reduction in investor earnings is more than half.
“These matters have become increasingly important since the late 1970s, when mutual funds started to gain favor as the retail investor vehicle of choice for retirement and other savings accounts,” Schacht noted.
According to the Investment Company Institute’s Investment Company Fact Book, the number of mutual funds in the marketplace has hovered just shy of 8,000 since the financial crisis took hold, compared with 564 in 1980. The number of shareholder accounts has grown to nearly 265,000 in 2013, from fewer than 10,000 in 1979. And total net assets, at $15 trillion as of year-end 2013, had grown at a double-digit compound annual rate of 15.4% from less than $135 billion in 1980.
Although the use of mutual funds and ETFs has exploded, cost disclosure requirements for these instruments haven’t kept pace. In particular, they differ by issuer, and by virtue of a late 1980s rule, are presented as a percentage of net assets. All of which, the IAC states in its report, leads to investor confusion about the true cost of these instruments.
To remedy the situation, the IAC provided three recommendations. First on its list is for the SEC to standardize cost disclosures, and second, to disclose actual dollar costs. The goal is to enable investors to easily recognize how much they are paying for different investment products without having to make what often amounts to complicated calculations.
The IAC also recommended that fund companies provide these disclosures within and as part of regular customer account statements. Customers have been shown to pay attention to these documents, and therefore are more likely to notice the costs, which they can then compare directly against periodic returns. Currently, cost disclosures are included in the annual shareholders’ report, a document the IAC contends is read rarely by investors.
“Considering the importance of mutual funds to retail investors’ investment portfolios, together with the enormous effect these costs can have on a lifetime of investment earnings, the committee agreed that greater understanding of mutual fund costs would be beneficial to many investors,” said Schacht. “The IAC has hopefully given the SEC some thematic guidance on how to take on these important decisions.”
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