Lipper Senior Research Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN

Tuesday, April 19, 2005

A. Sure. These are some cases where funds charge a management fee that isnot a fixed percentage of assets. Instead it is somewhat variable dependingon performance.

Q. Sounds like an equitable idea. Can you give us an example of how itworks?

A. Of course... Let's say you have a large-capitalization fund thatbenchmarks itself against the S&P 500 index. The fund might say somethinglike this: Our basic fee is 0.75% a year. But if we beat the index by atleast 2% (say +11% against +9% for example), we will get an extra 0.10% infee, so our total fee will be 0.85% that year.

Q. Does it work both ways, so if they do badly they would get penalized?

A. The Investment Company Act of 1940 requires that such formulas beexactly evenly balanced, so yes, in this case if the fund lagged the indexby 2% or more, its fee would be cut by 0.10% to just 0.65%. They can setany formula they want, of course, but it MUST be mirror image up and down.

Q. OK. How many funds do this sort of thing?

A. It is not very common. About 3% of funds, and they have a little under8% of the assets.

Q. Are there any well-known examples?

A. Fidelity and Vanguard between them have over 70 such funds (not alltheir funds by any means) which together account for almost 90% of theassets, about $500 million, that DO have contingent management fees.

Q. Why is it that so relatively few funds do business this way? Seems likea pretty fair way to treat the investors...

A. I think there are several reasons...

1. it would make the fund sound more like a hedge fund, although thehedge funds are not required to have a 2-way formula.

2. relatively small expense reductions are NOT a big asset magnet;performance itself is the big draw for net money flows.

3. the fact that the fee went down would highlight the fact thatperformance was in fact sub-par.

4. there is a complexity in calculating the fee as you go along everyday, which raises the cost of the accounting services.

5. THE BIGGIE: more funds UNDERperform than OVERperform, so theadvisor would be betting against the odds in most cases.

6. These kinds of fees would make revenue for the fund companiespotentially more volatile up and down.

Q. What IS the average expense ratio for funds, anyway?

A. On a dollar-weighted average basis, which I prefer since it tells whathappened to people's total combined money...

	Total Expense	Mgmt Fee
Equity Funds:	0.97%	0.57%
Bond Funds:	0.74%	0.44%

and of course this is total "expenses" but not commissions paid, andtotal the expense is more than just the fees we were talking about earlier.

Q. Besides contingent advisory fees, what other methods might a fund haveof varying its fee on assets?

A. Actual fee reductions (permanent). Those require a shareholder vote toauthorize raising them again. Temporary partial fee waivers; break-pointfees, where the percentage fee goes down as the asset size grows to certaintotal levels fee by complex, where a rate is set across all funds in thebrand rather than by the individual fund

Q. Wasn't there some controversy recently about these contingent fees, Don?

A. Yes, and it was an accounting thing. The SEC says a few fund companieshave been computing these fees the wrong way and so overcharging people...

Q. Names of some of the fund companies involved?

A.

• Putnam Bridgeway Capital Mgmt
• Access Capital Mgmt
• Numeric Investors
• Gartmore
• www Internet Fund (liquidated now)
• and one closed-end, the Taiwan Fund

Q. What was the problem?

A. Well the formula for how to calculate these fees is a little complex,and real problems can arise when there is a big change in the size of thefund due to either withdrawals or poor performance. How do you give backthe penalty part of the formula: in dollars, in basis points, in percentageof fee, and how do you calculate who gets how much refund, AFTER THE FACT?You don't know until after a year ends whether you failed to hit the targetreturn! What about people who sold out of the fund? What about peoplewhose account was so small that their refund would be less than the postageand check-processing costs? Can a fund charge contingent fees in good timesand then quit doing so in a bad market? Sticky stuff!

Q. How can investors find out if they were hurt?

A. First, read the prospectus and see if it quotes a contingent fee or astraight percentage. As I said, only about 3% of funds are involvedpotentially. Or call the 800# and ask them. If you are curious and LIKE thecontingent fee idea, ASK them why they do not do it. The answer could beinteresting.

Q. A minute ago you mentioned that commissions the funds pay to trade areOUTSIDE the so-called "total expense ratio??"

A. Right. It is a long-standing accounting convention and we at Lipper havesuggested it be changed. The AVERAGE equity fund last year spent about0.15% of assets on commissions, but some spent over a full percent. Thenumbers are hidden deep in the financial statements, in any of three placesthey choose to put them. There is a big loophole for funds that trade inbonds. Some 60 funds' trading commissions were more than their expenseratios, and 138 were more than 1.00%! We think this cost should be shownprominently, and all as one figure, since it impacts performance just likeother costs of the fund.

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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).