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WASHINGTON, D.C.///November 30, 2006///If you think “plain vanilla” index mutual funds are all pretty much the same, think again. Investors who buy index mutual funds through brokers are paying a steep “broker penalty” by being sold funds with much higher operating expense fees even before adding the distribution fees related to the cost of using the broker, according to a major new study by the Zero Alpha Group (ZAG) and Fund Democracy. The bottom line for investors: The extra operating costs paid over time for broker-sold load index funds are triple those paid by investors in true no-load mutual funds.

Authored by Edward (Eddie) O’Neal, assistant professor, Babcock Graduate School of Management, Wake Forest University and Fund Democracy President Mercer Bullard, the Zero Alpha Group/Fund Democracy study finds: “On a $10,000 investment earning an annual return of 10 percent over 20 years, the average investor in no-load, no 12b-1 fee index funds would pay approximately $2,582 in operating expenses. The average investor holding a no-load fund that charges a 12b-1 fee would pay $3,744, while the average investor holding load index funds would pay $7,600 in operating expenses. Although one would expect using a professional adviser to improve an investor’s performance, instead the investor pays a significant penalty … We found that load index funds charged substantially higher fees – even before counting the fees paid to the broker – than true no-load (no 12b-1 fee) funds. In other words, when investors used brokers they paid twice: first, they paid the broker; second, they paid a broker penalty in the form of higher fund fees.”

J. Christopher Kerckhoff, Jr., vice president, Plancorp, Chesterfield, MO., said: “These findings show that brokers are serving as agents of fund companies, not in the best interests of their investor clients. Our study is troubling for investors who use brokers to purchase load index funds. We would fully expect such investors to incur distribution costs associated with compensating their broker or advisor. However, there is no valid reason for such investors to have to foot the bill over and above what true no-load investors do for other, non-distribution services. Indeed, if one presumed benefit of distribution services is the selection of lower-cost index funds, one would expect no-load and load funds to have lower – not higher – operating expenses than true no-load funds.”

Mercer Bullard, president and founder, Fund Democracy, said: “Brokers are supposed to work for their clients, but when recommending a generic product such as an index fund, they refer their clients to more expensive funds and then collect sales charges to boot. Federal law requires that brokers charge the commissions that funds tell them to charge. It is time to end price fixing in the fund industry and cut the cord between mutual funds and the brokers who sell them.”

Richard Bennett, principal and financial advisor, Savant Capital, Rockford, IL., said: “This study is a powerful illustration of why investors who are dealing with glorified commissioned salespeople need to find a fiduciary … and fast. You can think of the index mutual fund ‘broker penalty’ this way: If a consumer spends $4 for a loaf of bread when an identical loaf on the same shelf cost $2, it is no defense for a ‘bread broker’ who recommends the $4 loaf to argue that it cost more because the baker has higher production costs than the baker of the $2 loaf. The extra $2 paid by the consumer is a broker penalty, and the fact that the consumer pay for that advice simply adds insult to injury.”

Providing an international perspective on the new study, Denys Pearce, managing director of the ZAG member firm Plan B Financial Services, Ltd., in Perth, Western Australia, said: “Whilst in Australia brokers mostly execute trades in direct equities rather than mutual funds, similar issues arise. Investors cannot clearly differentiate between those professional advisors who are acting in a fiduciary capacity and thus must always act in the best interests of their clients, and those who are not and thus may make a product recommendation that favors their best interests rather than the client’s. Although there are substantial fee disclosure requirements placed upon Australian financial advisors, we find that investors often don’t read them and frequently are unable to make valid comparisons.”

The study found that true no-load fund investors pay no distribution expenses and an average of 21.5 basis points in operating expenses, no-load fund (12b-1 fee/no commissions) investors pay 12.6 basis points in distribution expenses and 31.8 basis points in operating expenses. Load fund investors pay 15.6 basis points in distribution expenses and 70.4 basis points in operating expenses, which means that in return for an additional 15.6 basis points worth of distribution services they pay an extra 48.9 basis points for operating services over the amount true no-load investors pay. As such, the study concludes that the use of a broker results in investors being placed in higher cost funds – in effect, the imposition of a “broker penalty” – even after excluding the cost of the broker’s services.

The “broker penalty” observed in the ZAG/Fund Democracy study more than doubled when the analysis was asset-weighted. That is, when fund expenses were weighted by the amounts actually invested in different funds, the true no-load investor paid an average of 21.5 basis points in operating expenses, in comparison with the load investor’s average operating expenses of 70.4 basis points. As the study notes: “Adding insult to injury, the load investors paid sales charges to their broker, on top of the additional 48.9 basis points they paid to the load index fund in operating expenses.”

Index mutual funds are essentially commodities. They hold identical or almost identical sets of securities. Differences in their investment performance are explained almost entirely by fees, which are highly predictable. Index fund fees, however, vary widely. The expense ratios of the S&P 500 index funds reviewed in the Zero Alpha Group/Fund Democracy study ranged from .07 percent to 1.45 percent.

The Zero Alpha Group/Fund Democracy analysis is based on 141 index funds pegged to the S&P 500. The study dataset was gathered from the Morningstar Principia Pro Plus for Mutual Funds database, June 2006 version.

ABOUT THE GROUPS

Founded in 1995, the Zero Alpha Group (http://www.zeroalphagroup.com) is an international network of independent investment advisory firms that manage a total of more than $7 billion in assets. The nine current members of the Zero Alpha Group are committed to providing objective, long-term private wealth management solutions to investors, focusing on asset allocation and a structured, quantitative approach to investing. The firms in the Zero Alpha Group network share a common philosophy about investing and client service - a commitment to passive, tax-managed investment strategies while providing an independent financial planning solution for investors.

Fund Democracy (http://www.funddemocracy.org) is a 501(c)(3) nonprofit membership organization funded solely by public contributions. It was founded by Mercer Bullard to serve as an information resource for mutual fund shareholders and an advocate for shareholders' rights and interests. He is an assistant professor at the University of Mississippi School of Law, where he teaches courses on securities and financial institutions regulation. Bullard worked at the U.S. Securities and Exchange Commission (SEC) from 1996 to January 2000, where his last position was assistant chief counsel in the SEC's Division of Investment Management.

CONTACT: Info@ZeroAlphaGroup.com

EDITOR’S NOTE: A streaming audio replay of this Zero Alpha Group/Fund Democracy news event will be available on the Web at http://www.zeroalphagroup.com as of 4 p.m. ET on November 30, 2006.