Mutual Fund Management Fees Stay Reform-resistant

Minor fee changes will yield investors few cost savings.

June 2005: The Bachar Committee reforms are gaining steam and the banks are being forced to give up their mutual fund businesses. The unhappy banks make a last-ditch effort to salvage what they can. Thus, through political connections, they come out with commissions for selling the mutual funds they had managed.

That episode came to mind at an urgent meeting convened by the mutual fund association last week after the Israel Securities Authority announced the decision to reduce commissions paid by fund managers.

Anyone might have thought the managers would be thrilled by the move rather than despondent. But someone described the mood as "hysterical."

Fund managers are scared that lower commissions will spur banks to recommend competing products, such as exchange-traded notes.

The move by ISA Chairman Shmuel Hauser to cut commissions has the markings of a half-measure in easing the burden on the public.

The idea long under consideration and supported by fund managers was to slash commissions while adding transaction fees. This would ensure lower rates for the investment houses to pay without the banks losing income. Customers would make up the difference through the transaction fees. But legislation for this proposal fell through.

What did pass was just a minor change to commissions, so whatever savings customers might enjoy will be inconsequential.

In announcing the initiative, Hauser said it was time the public paid less, not just for cottage cheese or cell phone service, but for mutual funds. It seems, however, that he might be off the mark. The mutual fund industry, which manages NIS 153 billion in assets, is already considered one of the most competitive fields in the financial market.

Just the gradual reduction in management fees from a weighted 1.9% average in 2008 to 1.3% now shows that management fees charged today are relatively competitive - at least before taking into account the fixed fees assured for the banks.

Of the assets managed by mutual funds, 12% are in corporate debenture funds and 17% are in Israeli government bond funds. Management fees on such funds vary between 0.8% and 1.2%, while their commissions are 0.4% , meaning that fully one-third to half the management fees flow to the banks.

In the case of money market funds, accounting for 23% of the industry, the situation is even more extreme: Management fees average 0.15%, while commissions are 0.125% - so that over 80% of the fees go to the banks. These commissions are being reduced to 0.1%, and those on bond-based funds to 0.35%, which doesn't represent much savings in real terms.

The cutback in commissions on stock funds, from 0.8% to 0.4%, is much more substantial, but these funds comprise barely 7% of the industry assets. The banks, by the way, also enjoy another fee paid by customers: a maintenance fee that comes to 0.7% to 0.8% on average.

What exactly are the banks maintaining to earn this fee?

It's the public that's meant to enjoy the savings that come from lowering commissions: The ISA requires fund managers to reduce their management fees by the amounts the commissions are cut, for at least six months. This may be the reason that on Sunday Excellence rushed to declare a 0.05% hike in its management fees on its Makam Premium fund, which manages NIS 1.9 billion of assets, before the change goes into effect.

If Hauser wants to reproduce the cellular revolution in the mutual fund market, he'll have to make far more substantial changes than 0.05% cuts in commissions. Meanwhile, the banks are biting off a huge chunk of mutual fund management fees despite being relegated to the supporting role of marketing