We often talk about the importance of holdings analysis when it comes to ETF and mutual fund research. After all, the performance of the holdings equals the performance of the ETF/mutual fund. However, holdings are just one of the drivers of future fund performance. Investors also need to pay attention to costs when picking a fund.
Unfortunately, stated fund expense ratios don’t give investors the entire picture of what a fund costs. To provide a clearer picture, we developed our proprietary total annual costs (TAC) metric, which incorporates the expense ratio, front end load, back-end load, redemption fee, transaction costs, and opportunity costs. In other words, total annual costs give investors as accurate a measure as possible of the costs of being in any given fund.
We’re putting five of the most expensive mutual funds under coverage in the Danger Zone. Even if they had high-quality holdings (which they don’t), one can’t expect these funds to outperform due to their excessive fees.
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Five Funds That Gouge Investors
The five funds in Figure 1, American Growth Fund Series One (AMRAX), Rydex Series Nova Fund (RYANX), Pacific Advisors Mid Cap Value Fund (PAMVX), Pacific Advisors Large Cap Value Fund (PAGTX), and Advisors Preferred Quantified All-Cap Equity Fund (QACAX) have an average TAC of 8.14%. For comparison, the average TAC of all 7,200+ mutual funds under coverage is 1.77% while the asset weighted average is lower at 1.06%.
As shown in Figure 1, these funds’ expense ratios significantly understate the true costs to investors. In some cases, the TAC is more than five times higher than the stated expense ratio.
Figure 1: 5 Most Expensive Mutual Funds*
* Mutual funds exclude multiple shares of the same fund
Sources: New Constructs, LLC and company filings
Below, we analyze each of these five funds and quantify just what their high TACs mean for investors.
American Growth Fund Series One
AMRAX is managed using a “growth style of investing” and invests primarily in large cap common stocks and securities convertible into common stock. No matter how successful this process is, AMRAX’s 9.86% TAC earns it the dubious title of “most expensive mutual fund under coverage.” AMRAX’s TAC breaks down as follows:
To justify its higher total annual costs, AMRAX must outperform its ETF benchmark, the iShares Russell 3000 ETF (IWV) before all costs by 9.6% annually over 3 years or 8.0% annually over 10 years. AMRAX’s transaction costs are estimated using the fund’s annual portfolio turnover ratio of 11%. We can also quantify how much AMRAX’s TAC will cost over multiple holding periods. AMRAX’s 3-year accumulated total costs are $3,016 and just $80 for IWV. 10-year accumulated total costs are $13,293 for AMRAX and $514 for IWV.
The only justification for a mutual fund to charge higher fees than its ETF benchmark is “active” management that leads to out-performance. A fund is most likely to outperform if it has higher quality holdings than its benchmark. Leveraging our Robo-Analyst technology[1], we analyze the holdings of all ETFs and mutual funds under coverage. Through this analysis we find that AMRAX’s asset allocation looks more like closet indexing than active management. AMRAX allocates 34% of its value to Unattractive-or-worse rated stocks (IWV is 33%) and 22% to Attractive-or-better rated stocks (IWV is 23%). With little difference in asset allocation, investors can’t expect significant outperformance vs. the benchmark, yet are paying significantly higher fees. For comparison, IWV charges TAC of just 0.22%.
