Total Expense Ratio – A Misnomer

In our recent analysis of mutual funds of the largest wealth managers and private banks we have specifically looked at the Total Expense Ratio (TER). This ratio is the closest measure to evaluate the costs of a fund. But as our research shows the Total Expense Ratio is by no means a sufficient number to assess the real total costs of a fund. Our analysis included simple mutual funds, listed in Europe covering the most common market regions of USA, Europe, Asia and Global. The simple arithmetic mean of costs per region is in the table above. 

The highest Total Expense Ratio was a stunning 2.35% (UBS Equity Asia), the lowest 1.08% (BNP Parvest Asia Classic). If you compare the Total Expense Ratio of the funds to the Total Expense Ratio of passive products like Exchange Traded funds (ETFs) or Index funds that usually have a Total Expense Ratio between 0.10% and 0.75% you can easily calculate how much an investor saves just through the cost difference. Just think about a cost difference of 1% over five years. It adds up to a performance difference of about 5%. 

The hefty product fees charged by the asset managers for the funds (therefore in effect reducing the wealth of the investors) is one and in most cases the major reason why they do not beat their benchmarks. Adding up the total costs taken out of clients’ assets per year we arrive at the total of USD 405 million (total assets under management just of the evaluated funds were USD 22.71 billion as of July 31 2009). 

The Total Expense Ratios as listed above might seem already out of proportion to many investors. However, this is not the end of the story. Opposed to the term “Total Expense Ratio” in most European countries not all expenses of a mutual fund are covered. Not included in the Total Expense Ratio are for instance:

• Transaction costs as a result of trading of the fund's assets (like brokerage fees, exchange fees and stock market taxes).

• Performance fees and other costs like consulting fees and meeting expenses.
  

• Fees that an investor has to bear as a consequence of buying or selling a fund, such as front/back loads.
  

Fund experts, like the independent fund manager Alan Miller, estimate that the real total expenses can be more than double of the officially published total expense ratio. In consequence, a fund investor can pay easily up to between 3% to 4% costs for an equity fund which he will never be openly charged for. Over a ten year period these costs will lower the investment performance by 30%-40%.

We think it is about time that the fund industry opens the books and discloses not only the Total Expense Ratios but also the full costs. This would serve not only the clients’ interests, but also their own, because otherwise investors will keep fleeing in ever growing number into the arms of inexpensive and transparent ETF funds.