MUTUAL FUND MORTALITY, 12B‐1 FEES,AND THE NET EXPENSE RATIO

The Securities and Exchange Commission is currently reviewing Rule 12b‐1, which governs how fund advisors may pay for the distribution of fund shares. We provide evidence that even after adjusting for economies of scale, funds with 12b‐1 fees have higher expense ratios net of the 12b‐1 fees than do funds without such fees. This finding suggests that 12b‐1 fees are more than just a deadweight cost. We also demonstrate that 12b‐1 fees are highest for funds that ultimately fail, that the proportion of funds with 12b‐1 fees is increasing over time, and that the level of those fees is also increasing over time.     

INFLUENCES AND TRENDS IN MUTUAL FUND EXPENSE RATIOS

A common question for the mutual fund industry, which has experienced a fivefold increase in assets over the last few years, is whether it shows declining production costs. Prior studies on fund expenses give conflicting results because several factors, from asset size to management style to share class, affect costs. Controlling for these and other factors shows the average stock fund expense ratio declined 1 basis point per year and bond fund ratios decreased 1 to 3 basis points per year, depending on the investment objective, from 1994 to 1998. Funds participating in no‐transaction‐fee supermarkets are more expensive than equivalent nonparticipants. JEL classification: G20, G28     

THE COST OF MUTUAL FUND DISTRIBUTION FEES

Many individuals purchase shares in mutual funds as investments. With a lack of evidence supporting performance persistence in fund returns, investors should consider expenses as a fund-selection tool since fund expenses have a negative effect on fund returns. One of the largest expenses incurred by fund investors is distribution expenses, which include both load charges and annual fees. Close to two-thirds of all equity funds charge investors for fund distribution. The true cost of these distribution fees to investors is hard to measure because a myriad of distribution arrangements have evolved that vary both the timing and magnitude of distribution charges. We derive a simple methodology that expresses the present value of distribution costs as a percentage of the original investment in fund shares for any expected holding period. This methodology allows direct comparison of the effect on investors of distribution fees for mutual funds with different types of sales arrangements.     

A RE-EXAMINATION OF THE RELATIONSHIP BETWEEN CLOSED-END FUND DISCOUNTS AND EXPENSES

In this paper the role of expenses in explaining closed-end fund discounts is re-examined. A present value model is developed to illustrate the relationship between expenses and discounts. Earlier studies find that discounts are not related to management fees. In this paper, using a larger sample over a longer and different period and a better specification of the expense variable consistent with the model developed, discounts are found to be significantly related to expenses. The relationship between expenses and discounts holds in the presence of other control variables.     

A CASE OF MISTAKEN IDENTITY: THE USE OF EXPENSE/REVENUE RATIOS TO MEASURE RATIOS TO MEASURE BANK EFFICIENCY

First Interstate Bancorp, in announcing the next phase of its ongoing strategic plan, said its goal is to move its 1995 expense/revenue ratio to 58% from 65·7% in 1993. The expense/revenue ratio is considered to be a key measure of a bank's operating efficiency.     

TEMPORAL CHANGES IN THE DETERMINANTS OF MUTUAL FUND FLOWS

We examine how the relation between mutual fund performance and fund flows has changed over time by separating our sample into two periods (1978–87 and 1988–97). We document an increase in the flow‐performance asymmetry in the second period that exacerbates the adverse incentive for fund managers to increase portfolio risk. We develop a measure of the elasticity of fund flows with respect to performance, which filters out the confounding influence of greater aggregate fund flows in the second period and allows an examination of whether current investors place more emphasis on prior performance when selecting funds. We conclude that, though top performing funds are rewarded with greater fund flows in the second half of our sample, the change is due solely to the increase in aggregate fund flows and not to an increased reliance on performance by individual fund investors. JEL classification: G1, G2, L1.     

THE EFFECT OF A SINKING FUND ON THE REOFFERING YIELDS OF NEW PUBLIC UTILITY BONDS

In this study, empirical tests are conducted to determine the impact of a sinking fund on reoffering yields of a sample of new public utility bonds sold between January 1977 and March 1982. The findings of the regression analysis are consistent with the hypotheses that the value of the sinking fund varies with the default risk of the issuer and with market expectations of future interest rate movements, and that the sinking fund improves the liquidity of a bond issue.     

THE EFFECT OF SFAS 87 ON CORPORATE FUNDING OF DEFINED BENEFIT PENSION PLANS

Statement of Financia1 Accounting Standards No. 87 (SFAS 87) modifies the method of accounting for pensions by requiring companies sponsoring defined benefit pension plans to (1) recognize a balance sheet liability for unfunded pension benefits and (2) disclose their obligation for pension benefits based on expected future compensation levels (the projected benefit obligation). These requirements may affect users' perceptions of a company's financial position, especially if these plans are underfunded. This research examines whether the requirements of SFAS 87 result in increased funding of corporate pension plans to counteract possible adverse perceptions of users about these plans. The results indicate that early adopters (companies adopting SFAS 87 in 1985 and 1986) increased the funding of their defined benefit pension plans in response to SFAS 87 ; however, later adopters did not do so. These findings provide evidence that companies may alter economic policies when faced with significant changes in financial disclosure requirements. Further analysis suggests that the effect of SFAS 87 on the pension expense recognized by the sample companies provided impetus for early adoption of this pronouncement.     

IMPORTANCE OF THE FUND MANAGEMENT COMPANY IN THE PERFORMANCE OF SOCIALLY RESPONSIBLE MUTUAL FUNDS

We compare the performance of a sample of U.K.‐based socially responsible investment (SRI) funds with similar conventional funds using a matched‐pair analysis based on size, age, investment universe, and fund management company (FMC). We find that both the SRI and conventional funds outperform the market index about 50% of the time, even after fees. Subsample tests show that the SRI funds in our sample perform better in the pre‐ and postfinancial crisis periods but underperform during the financial crisis period. Importantly, we find that the FMC plays a major role in the outperformance of both SRI and conventional funds.     

MUTUAL FUND PERFORMANCE IN THE CONTEXT OF MODELS OF EQUILIBRIUM CAPITAL ASSET PRICING

This paper examines the question of mutual fund performance within an equilibrium asset pricing framework, and in particular gives attention to the reinterpretation of tests of fund performance provided by Peasnell, Skerratt and Taylor ( JBFA 1979). The paper concludes that the reinterpretation provided by Peasnell et. al is flawed, and moreover, that prospects for some new interpretation are bleak.     

A RE-EXAMINATION OF THE PROXY HYPOTHESIS

In this study we examine whether the proxy hypothesis can explain the puzzling negative relation between real stock returns and expected inflation. Our study improves upon previous tests that suffer from model misspecification and are incomplete. With correctly specified models, we provide a comprehensive test using data from four major industrialized nations during the period of floating exchange rates. Results do not support the proxy hypothesis.     

THE EFFECTS OF MUTUAL FUNDS ON M&A COMPENSATION

Motivated by shareholders’ interest in combating executive wealth expropriation through the merger and acqusition (M&A) process, we study how mutual funds influence firm behavior around an acquisition through votes against management proposals. We find that mutual funds reduce the chief executive officer's ability to extract rents during the M&A process by voting against management‐sponsored compensation proposals after the acquisition, thus lowering both excess compensation and increasing pay‐for‐performance sensitivity. Furthermore, mutual fund voting magnifies the impact on negatively performing firms and firms with a larger amount of the mutual fund's holdings in the firm.     

MUTUAL FUND PERFORMANCE PERSISTENCE AND COMPETITION: A CROSS‐SECTOR ANALYSIS

Existing work on mutual fund performance persistence obtains diverse results, depending on the group of funds studied. We examine whether performance persistence within a peer group of competing mutual funds depends on the group's composition. The U.K. mutual fund industry is ideal for such an examination because funds compete within strictly defined sectors. We consider several attributes related to the intensity of competition within a sector and use them to explain sector‐level persistence. We find robust evidence that persistence is higher in sectors where concentration of assets under management is higher.