Small Cap Fund Trading Costs the Worst at 123 Percent of Reported Expense Ratios; New Look At Over 5,000 Funds Confirms Finding of Smaller ZAG Study From Early 2004

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WASHINGTON, D.C.///November 17, 2004///U.S. investors in equity mutual funds are paying $17.3 billion in hidden mutual fund trading costs that are not reported openly in the stated expense ratios of mutual funds, according to a new Zero Alpha Group (ZAG) study of over 5,000 equity funds. The Zero Alpha Group is a nationwide network for eight independent investment advisory firms that manage a total of more than $3.5 billion in assets.

Conducted by Edward O'Neal, assistant professor of finance at the Wake Forest University Babcock Graduate School of Management, and Jason Karceski and Miles Livingston at the University of Florida, the ZAG study looks at more than 5,000 domestic equity funds and finds that trading costs were, on average, 43.4 percent as large as reported mutual fund expense ratios. For many mutual funds, these costs of trading exceed stated expense ratios. According to the study: “46 percent of all small cap funds have “all-in” trading costs that are higher than the annual expenses investors pay. 21 percent of mid cap funds fall into that category as do 7 percent of all large cap funds. In the small-cap category, 17 percent of all funds have implicit trading costs that are twice the level of annual expenses.”

The ZAG study, which is entitled “Portfolio Transactions Costs at US Equity Mutual Funds” also concludes that growth funds have higher than average trading costs as a percent of annual expenses: The growth funds are broken down into large cap growth (with trading costs averaging 43.1 percent of stated expense ratios), mid-cap growth (86.0 percent), and small-cap growth (123.2 percent). Hidden expenses for value funds are lower than with growth funds, the study found.

Scott Sarber, vice president, Petersen Hastings Investment Management of Kennewick, WA., said: “Mutual fund investors can easily find information on the annual fees that mutual funds openly charge investors. However, that transparency only goes so far; it doesn’t get at another cost of mutual fund investing: the cost inherent in portfolio trades directed by fund advisors. Only a part of that extra cost is detectable through publicly available documents and that is only if you dig into obscure mutual fund documents that very few investors know anything about. When you add on top of that the completely unreported implicit costs of trading, you are left with a big credibility gap in mutual fund reporting to investors.”

Gregory Carlson, president, Carlson Capital Management, of Northfield, MN., said: “No one is suggesting that people should stop buying mutual funds. We completely recognize that these funds are the only practical way for most investors to achieve proper diversification and to manage risk. But better disclosure and education are clearly needed to ensure that investors understand the true costs of owning mutual funds. We are a long way away today from achieving genuine transparency in terms of revealing the real costs associated with these funds.”

Kimberly Sterling, vice president, Resource Consulting, of Orlando, FL., said: “For a marketplace that is supposed to run on openness and full disclosure of costs and risks, there is a genuine problem today when real trading costs can run well over what is being published as the cost of investing in mutual funds. What we are seeing in these funds is a confirmation that expense ratios are only part of the picture. These are the kind of undisclosed costs that would never be accepted by consumers if we were talking about a mortgage or buying an automobile. The fact that the products involved are mutual funds – the cornerstone of retirement planning for most Americans – makes it even more imperative that consumers get clear and complete information about what it really costs to own a mutual fund. Funds with higher hidden costs have a greater drag on performance. Investors are making decisions without this important information.”

One of the starkest conclusions from the study was the difference in trading costs between index funds and actively managed funds. The total trading costs of active funds were 0.48 percent per year. The trading costs of index funds averaged 0.064 percent per year. Study author O’Neal said: “That investors in actively-managed funds incur portfolio trading costs that are over seven times that of index fund investors is another in the long line of reasons for investors to favor index funds.”

UNDERSTANDING THE STUDY

The ZAG study analyzes the explicit and implicit trading costs for 5,000 U.S. equity mutual funds. The explicit trading costs are brokerage commissions that funds pay to effect trades for their portfolios. Information was collected on the actual commissions paid for the sample of mutual funds for fiscal year 2002. Implicit trading costs include bid-ask spreads and market impact costs that are more difficult to quantify. The researchers calculated these costs by applying estimates of per-trade implicit trading costs for institutional investors to the reported mutual fund turnover rates of the sample. The study then combines the explicit and implicit costs and compares the “all-in” number to reported annual fees.

Complete findings from the new November 17, 2004 ZAG study are available online at http://www.zeroalphagroup.com.

An earlier January 23, 2004 study by ZAG examined the “true costs” of owning the 30 top domestic equity mutual funds in the United States, representing roughly $750 billion in investor assets through the end of calendar year 2001. The study finds that 43 percent of the funds’ expenses are omitted from their expense ratios and that the transaction costs of some funds exceed 400 percent of their expense ratios. According to the January 2004 ZAG study, the inexpensive index funds were the Vanguard Total Stock Index Fund (23.4 basis points), Vanguard 500 Index Fund (21.5 basis points) and Fidelity Spartan U.S. Equity Index Fund (21.5 basis points). At the other end of the spectrum, the Fidelity Fund (161 basis points), Fidelity Contrafund (164 basis points) and Putnam Voyager A Fund (167 basis points) were found to have the highest total costs for investors.

ABOUT ZERO ALPHA GROUP

Founded in 1995, the Zero Alpha Group, which is not an investment advisory firm itself, was created to serve as a nationwide network for eight independent investment advisory firms that manage a total of more than $3.5 billion in assets. Members of the 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 eight 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. Visit ZAG online at http://www.zeroalphagroup.com.

CONTACT: Patrick Mitchell, (703) 276-3266 or .