Measuring the Cost and Effectiveness of Fund Directors - July 2008 Print E-mail
Written by C. Meyrick Payne and Jay Keeshan   

C. Meyrick Payne and Jay Keeshan, Management Practice, Inc (MPI).  Data for this Bulletin is principally drawn from the  MPI Annual Survey of Trustee Compensation and Governance Practices.

Independent mutual fund directors, who have the authority to annually review and renew the investment advisory contract, have proven to be a cost efficient and effective way to govern the collective investments of millions of Americans. Occasionally this statement is called into question. In the paragraphs which follow, we highlight four ways to quantify the cost efficiency and market effectiveness of independent mutual fund directors.

1. FOR FUND SHAREHOLDERS

The cost of mutual fund directors to fund shareholders is quite small, especially when compared to the impact they have on overall fund expenses, which is significant.
The cost of one fund director varies between roughly $36.67 per $1 million in assets for the smallest fund groups, to $1.80 per $1 million for the largest. On average there are 5 independent directors in a small complex for a total board director cost of $183 per $1 million; there are 8 directors in the typical large complex for a total cost of $14.40 per $1 million. Overall the total board director cost is an average of $14.23 per $1 million. On average the total expense ratio of all mutual funds approximates 1% or $10,000 per $1 million.  Therefore fund directors have leverage over fund expenses of 703 to 1 (i.e. $10,000 divided by $14.23)1.

2. RELATIVE TO CORPORATE DIRECTORS

Mutual fund directors are many times more cost effective than corporate directors in terms of their impact on the capital markets of the United States.
As of December 31, 2007 there were 2,590 independent mutual fund directors overseeing $12 trillion in assets; this equates to $4.64 billion per director. Within the entire population of fund directors there were 230 fund directors at the largest 25 complexes, which have about 60% of all fund assets or $7.3 trillion; this equates to $31.74 billion per director2.
As of December 31, 2007 there were about 25,200 independent directors of 2,805 companies which are listed on the New York Stock Exchange. The total market capitalization of these companies was $27.1 trillion. Therefore each NYSE director oversees about $1.07 billion in market capitalization.3
The comparative economic impact of directors of the largest mutual fund complexes is 30 times that of directors of NYSE listed companies ($31.74 billion divided by $1.07 billion).

3. COMPARED TO THE GOVERNANCE STRUCTURE OF OTHER COUNTRIES

The beneficial impact of fund directors can be demonstrated by a comparison of expense ratios for US funds compared to funds in other countries, where fund directors do not have the same authority as US directors.
 
All US mutual funds take a corporate form with independent directors, who have the authority to replace the fund advisor (subject to ratification of the new advisor) and to lower the investment advisory fee or other affiliated fees. Most other countries, including those with UCITS as the dominant fund form, do not give fund directors (if they have them at all) this authority.
An analysis of the total expense ratios of funds in a variety of countries showed that all were higher than the US. The expense ratio of equity funds in Belgium averaged 65% higher; for Germany 67% higher; for UK 74% higher; for Austria 124% higher; for France 125% higher; for Luxemburg 127% higher; and for Canada 154% higher4.
The difference in the governance structure, namely the existence of independent directors and their authority to terminate or alter the investment advisory contract, undoubtedly accounts for a good portion of the difference in total expenses. Another portion may be explained by the difference in size and longevity of US funds.

4. FOR THE US TAXPAYER

From the perspective of the US taxpayer, the current structure of mutual funds is both cost-efficient and highly effective.
There are about 400 employees of the SEC who regulate mutual funds. These are supplemented by 2,590 independent fund directors, bringing the total number of individuals responsible for oversight to about 2,990. The US retail banking industry is approximately the same size as the mutual fund industry. There are about 30,000 bank regulators at the federal, state and local levels5. As a result the US taxpayer is more cost effectively served by the mutual fund regulatory structure.
In terms of effectiveness, mutual funds have had comparatively few scandals. The market timing and late trading scandals of 2002 were exceptions. Even those had minor impact on individual fund shareholders, and none on US taxpayers. On the other hand, banks have had numerous scandals, including the Savings and Loan crisis and now the sub-prime crisis, which have been extremely expensive for bank shareholders and taxpayers.

***

In sum, the governance structure of US mutual funds has been wonderfully successful by every measure. The fund shareholders have benefited, the industry has benefited, the taxpayers have paid a relatively small price and, above all, the fund industry has grown to be the dominant savings vehicle for 90 million Americans.


1 Survey of Mutual Fund Trustee Compensation and Governance Practices, First Release, April 2007, Management Practice Inc. Page 15
2 Ibid, Page 22
3 NYSE Website
4 Letter of C. Meyrick Payne and Jay A. Keeshan to the SEC dated February 20, 2007 citing analysis of International Expense Ratios complied by Standard and Poors, Inc., SEC File S7-03-04
5 Various US Government websites
 
< Prev   Next >