June 3, 2009 / 10:10 PM / 10 years ago

Fund trading costs higher than many items - studies

* Trading costs average around 1.5 percent for funds

* Specialists seek firmer measures to count such costs

By Ross Kerber

BOSTON June 3 (Reuters) - Trading costs for mutual funds — largely hidden from investors — average around 1.5 percent a year, higher than many disclosed expenses, two new studies found.

“If you can show the actual trading costs, the hidden part of the iceberg is finally revealed,” said Arijit Dutta, associate director of research at Morningstar Inc, who authored one of the studies.

Separately, University of California Professor Roger Edelen and two co-authors found that trading costs are comparable to funds’ expense ratios and often exceed them. “We think our study really nails down that these costs do matter more than expense ratios,” Edelen said.

The researchers presented their findings at an investment conference sponsored by Chicago-based research firm Morningstar last week. The Morningstar study is at a preliminary stage, while Edelen’s is being reviewed by peers before it is published.

Trading costs, which mutual funds incur for their investors when they trade stocks, have been one of the fund industry’s most vexing subjects because there are no agreed-upon standards to account for them. This contrasts with traditional fund expenses such as the salaries paid to fund managers or accountants.

In Washington the subject is controversial as moves gain steam to require more fee disclosure around company 401(k) savings plans, which invest about half their assets in mutual funds.

Some trading costs, such as commissions paid to brokers, are simple to calculate. More difficult are items such as the impact that a major trade has on the overall price of a stock.

Edelen’s study sought to estimate costs among a sample of individual funds, going beyond his 2007 study which found that trading costs are comparable to funds’ expense ratios.

The new study identified funds that trade a lot compared to peers of similar size. They also used securities filings to estimate brokerage costs, and a formula to estimate the impact some trades had on the stock price.

Among 1,758 US equity funds, the study found a mean average trading cost of 1.44 percent, versus an average expense ratio of 1.19 percent. Large-cap funds tended to have lower trading costs than small-cap funds, partly their trades had less impact on the price of widely traded large-cap stocks.

Morningstar’s study aimed to generate actual trading cost figures for particular funds. It found average trading cost impacts of 1.64 percent among 2,075 funds — close to Edelen’s figure of 1.44 percent. It also found that small-cap funds had larger trading cost ratios than large-cap funds.

“It’s encouraging that it’s in the same ballpark” as Edelen’s study, Dutta told Reuters.

Reporting by Ross Kerber; Editing by Richard Chang

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