Is it worth paying higher bond mutual fund management fees?
Simply put, if you pay higher bond mutual fund fees, then these bond management expenses tend just to be a “deadweight” loss to you. The best bond fund buying strategy is to pick only very low-cost no load bond funds.
In pursuit of higher risk-adjusted bond mutual fund returns, many investors wonder whether it is worth paying higher expenses and fees. If they do pay more, will they get better mutual fund performance? Will higher performance outweight the added expenses? Investment science provides a strong “no” as the answer. When you pay more in bond mutual fund fees, you are just wasting your money.
Higher bond mutual fund fees hurt the performance of all types of fixed income funds
In “Bond Fund Returns and Expenses: A Study of Bond Market Efficiency,” Professor William Reichenstein of Baylor University studied the relationship between bond mutual fund returns and expenses.1 Professor Reichenstein analyzed bond mutual fund expenses and returns for the years 1994 to 1998.
To ensure that he was comparing bond funds of similar characteristics, Professor Reichenstein grouped bond mutual funds by their investment styles. Fund groups were differentiated by maturity (short-, medium-, long-term maturities) and investment grade quality (low, medium, high quality). Within each of the nine combinations of these maturity and quality style groups, he assigned each individual fixed income fund to one of three equal sized groups according to the fund’s expense ratio (low, medium, high expenses).
Professor Reichenstein tested several theories about investment returns and expenses over 1-year, 3-year, and 5-year time horizons by comparing average investment returns between these nine maturity and quality groupings. For example, he compared the average net return of the low cost group to the medium cost and the high cost groups of the same style to see whether higher fees produced greater returns, and so on. Without failure, Professor Reichenstein found that higher expenses predicted lower returns in 42 out of the 42 group comparisons.
Professor Reichenstein cited other studies of fixed income mutual funds expense and return averages that yielded similar results. For example, Jonathan Clements used Morningstar data that grouped bonds into five categories: government backed mortgage, corporate, U.S. Treasury, general municipal, and high-yield bonds.2 Clements found that in 28 out of 30 comparisons higher expenses meant lower returns to the investor. In 1999, Clements updated his 1991 study and found that higher expenses still meant lower returns to the investor, this time in 15 out of 15 cases.3
Again, higher bond mutual fund expenses lead to lower bond mutual fund performance
In addition, in 1999 John Bogle analyzed bond maturity and quality groupings for government, corporate, and municipal funds.4 He found that in 24 out of 24 comparisons higher expenses meant lower returns. In summary, 109 of the 111 comparisons in these four studies indicated that higher average expenses meant lower returns to investors.
Superior performance of specific bond mutual funds could have been obscured by comparing only the averages between groups. Therefore, Professor Reichenstein tested whether individual funds within his maturity and quality groupings delivered returns that compensated for their higher expenses. Again, his conclusion was no.
In fact, his analysis indicated that higher bond mutual fund expenses were a dollar for dollar “deadweight loss.” The higher the expenses, the lower the net return was for the individual investor. Professor Reichenstein’s analysis also concluded that the performance of similar bond funds with and without front-end loads was not statistically distinguishable. Additional expenses and investment broker sales loads just tended to result in a dollar-for-dollar reduction in investor’s assets.
Pay more to get less. Hmmmmm… Since when is that at good idea? Save your money. Ignore what commissioned bond mutual fund brokers and investment counselors tell you. Higher costs and sales loads to not deliver better bond mutual funds. Seek out and buy low cost, no load bond funds. Buy them directly from the mutual fund company to save money. It is your money. Hold on to it!
1) Reichenstein, William. “Bond Fund Returns and Expenses: A Study of Bond Market Efficiency.” Journal of Investing, Winter 1999: 1-9
2) Clements, Jonathan. “In Picking Bond Fund, Expense Factor Remains the Key.” Wall Street Journal, April 4, 1991, p. C1.
3) Clements, Jonathan. “If Your Manager is So Smart, Why are his Expenses So High?” Wall Street Journal, July 6, 1999, p. R1.
4) Bogle, John, C. Bogle on Mutual Funds: New Perspectives for the Intelligent Investor. Burr Ridge, Il: Irwin, 1994