ers and unaffiliated directors. They have thus far been applied in such a way as to shield the fees from judicial scrutiny rather than to enforce protections for fund shareholders. In this connection, I direct your attention to the statement of Judge Friendly, which was submitted to this committee and released by the committee because Judge Friendly, unfortunately could not be here this week. I would like to speak a little bit now about the record of what we consider to be excessive advisory fees. B. THE RECORD OF EXCESSIVE ADVISORY FEES It is clear and I do not think it has been denied that there are substantial economies of scale in the field of investment management, just as there are in most other fields of endeavor. It certainly does not cost 10 times as much to advise a billion-dollar fund as it costs to advise a $100 million fund. Chart A, which is one of a number of charts included in our statement, is intended to present that picture graphically. I will not take the time of the committee now to discuss this chart. In hearings on the act in 1940, the then chairman of the board of Massachusetts Investors Trust, at that time the largest mutual fund, and still one of the very largest, testified, and I quote him: It is now almost axiomatic in the trust business that operating costs decline proportionately as the size of the trust increases. This view has been confirmed time and time again. It was formally confirmed some 20 years later in the Wharton School report. Our report of last December contains current proof of this undeniable fact. These economies have served to expand dramatically the revenue of most advisers with relatively little increase in the size of the adviser's staff or the number of securities in fund portfolios. Indeed, in some cases the number of securities in the portfolios has decreased. Nevertheless, the facts with respect to fees are these: 1. The traditional formula for advisory fees in the investment company industry has been a flat 0.50 percent of average net assets per annum. In some cases an additional fee calculated in the same way has been and is charged for nonadvisory management services that is, housekeeping services and other management services. 2. Prior to 1960 the fund managers, with rare exceptions, made no move to lower these fees. Many funds grew in net asset value from $50 million to $500 million or even $1 billion. Table III-6 at page 112 of our report compares the 1953 and the 1962 fees, and I direct your attention to it. The 0.50 percent advisory fees still remained constant. Fund managers with outstanding performance, mediocre performance, and even those with poor performance were generally paid at substantially the same rate of approximately 0.50 percent per annum. And, in instances too numerous to ignore, they still are. I will submit for the record a study we made which shows the funds with a one-half of 1 percent advisory fee and no scaledown despite the tremendous growth in their size. (The information submitted is contained in the following table:) up to STEPS IN ADVISORY FEE RATE SCHEDULES AND RESULTING ADVISORY FEE AND EXPENSE RATIOS OF EXTERNALLY MANAGED MUTUAL FUNDS WITH JUNE 30, 1966, NET ASSETS OF $100,000,000 Name of fund (in order of net assets under 1st step) AND OVER [Advisory fee rates are shown on an annual basis; net assets are in millions of dollars.] 3d step 1st step 2d step 4th step fee rate up tofee rate Percent of Net assets Percent of Net assets Percent of Net assets Percent of Net assets fee rate up to up to fee rate 1 The specified fee rate applies to the excess of the net assets appearing in this column over the amount shown in the preceding net assets column. 2 Ratio to average net assets for fiscal years ended July 1, 1965, to June 30, 1966, on the basis shown 3 Fees include the management fee paid to the investment adviser and a continuing fee paid to the 4 The fee is subject to reduction by certain adjustment, depending upon the amount of net assets; & Fees include those paid to the fund's investment adviser and to its business manager. Includes nine funds, five of which each had net assets in excess of $100 million. The fee rates 7 The fee rates are charged on the combined net assets of all series. Fees are reduced by $170,000 annually from those computed in accordance with the scale. 10 A rate of 0.35% is charged on net assets over $1.4 billion up to $1.65 billion; 0.32% on net assets 11 Fees are reduced by $130,000 annually from those computed in accordance with the scale. 12 Fees are reduced by $36,000 annually from those computed in accordance with the scale. 13 The fee rates are charged on the combined net assets of all series. The rates shown were effective 14 The fee rates are charged on the combined net assets of all series except one with net assets Commencing September 1, 1965, fees were reduced by 40% of the net income of a subsidiary 15 The fee is 6% of gross investment income rather than a percentage of net assets. 16 The fee is a combined investment management, administrative, and trusteeship fee of 0.50% 17 Fees reduced by $150 per $1 million, or by 0.015%, of average net assets. 18 Average net assets in the 12 months ended November 30, 1965, for which this expense ratio was computed, were approximately $36 million. 19 The fund was in operation for less than the entire fiscal year. In 1960 the Commission authorized the Wharton School of Finance to conduct a study of the industry. For some years before that it was generally known and understood that the Commission was considering the best manner in which to undertake or have undertaken for it a study of the industry in response to the statutory directive contained in section 14(b) of the Investment Company Act which was adopted in 1940 and which placed an obligation upon the Commission to report to the Congress its findings as to the effect on the public interest and the other factors there enumerated as the size of the industry grew. About that time, over 50 shareholder derivative suits were being brought against the advisers to most of the major funds. It was not until then that any general changes were made in advisory fee rates. In all fairness, I should say there were some funds that had already undertaken to make certain adjustments, including at least one of the very largest. In fact, that particular fund that I have in mind had initiated a breakpoint in its fee schedule a substantial number of years prior to 1960. Nevertheless, despite the further dramatic growth of the mutual fund industry from $18 billion in 1960 to $38 billion in 1966 and to approximately $45 billion now, no substantial reduction has been achieved to date in many cases. Although limited scaledowns from the basic 0.50 percent fee are now widespread, usually the amount of the scaledown is small and does not take effect except at the very highest levels. By way of interest, some of these scaledowns were usually fixed at a point which is approximately twice the size of the fund at the time. that the change was effected, which meant it was something to be hoped for in the future, not to be realized in the present. The median advisory fee paid by the 59 externally managed mutual funds with net assets of $100 million or more in fiscal years ending in 1966 was still 0.48 percent, down only 0.02 percent from the traditional 0.50 percent rate. I will furnish for the record a table giving you the precise information. (The table follows on next page:) ADVISORY FEE RATES AND EXPENSE RATIOS OF EXTERNALLY MANAGED MUTUAL FUNDS WITH JUNE 30, 1966 NET ASSETS OF $100 MILLION AND OVER FOR THEIR FISCAL YEARS ENDED IN 1966 1 As noted at pp. 90-92 of the Report of the Securities and Exchange Commission on the Public Policy Implications of Investment Company Growth, the nonadvisory expenses covered by the advisory fee vary among the funds. The advisory fee rate is the advisory fee as a percentage of average net assets. The fee rates used are those given in the prospectus. In those dases where the rate was not given it has in most instances been calculated pursuant to the following formula: Advisory fee rate Average net assets have been calculated pursuant to the advisory fee average net assets following formula: Average net assets *Includes entire MAT fee. See pp. 89-90 of the report. operating expenses. *Includes investment management and recurring fees paid to its trustee. See pp. 92-93 of the report. $Includes the management fee and continuing fee paid to the underwriter which is closely affiliated with the investment adviser. See pp. 93-94 of the report. Includes both the fees to the fund's investment adviser and its business manager. See p. 94 of the report. 82-865-67-pt. 1-3 |