The Mutual Fund Scandal – much ado about nothinig

Let’s take it for granted that insiders have used the peculiar pricing practices of the mutual fund industry to transfer some profits from buyers. According to some accounts, hundreds of millions of dollars have been transferred in this way (see Tyler’s posts here and here). But remember mutual fund buyers get quarterly statements showing their returns net of all chicanery. Is it so hard to believe that buyers make their decisions based upon their actual returns? A mutual fund that performs poorly is a mutual fund that performs poorly regardless of whether this was due to bad investment decisions, high expense ratios, or a slick transfering of funds. A few investors might buy and then accept any return as a matter of luck but the marginal investor can and does move funds around easily (what market is more contestable?) – not to mention the institutional investors. As a result, it makes little difference whether the managers get their return through the above-board expense ratio or the under-handed exploitation of stale pricing.

Sure, there may be some exploitation at the margin but this is akin to banks that charge fees for “free checking” or restaurants that include a gratuity in their bill. It’s annoying and the occasional consumer may be dunned but once consumer and competitor responses are taken into account the net transfer is small.

If you doubt the above, assume that we eliminate all under-handed practices. Do you think that consumers will now earn higher returns? Or, do you think, that other fees will rise to make up the difference? I predict the latter. The only danger is that in their haste to make political hay the politicians will end up passing some dumb law that makes everyone worse off.


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