Are confusing disclosures at the heart of high fund fees?

Academic research suggests mutual-fund firms use unnecessarily complex language to mislead investors

Are confusing disclosures at the heart of high fund fees?

While mutual-fund investors should by now realize how high fees can eat into their investment returns, they may not be able to put that knowledge to use – and asset managers’ confusing language could be the culprit.

In a working paper titled Disclosure Obfuscation in Mutual Funds, researchers from the University of Washington, Stanford University, and the Wharton School of the University of Pennsylvania took a sample of 38 U.S.-domiciled mutual funds tracking the S&P 500 and analysed them in terms of their total fees, as well as the level of complexity in their disclosures.

“S&P 500 funds have largely homogenous non-discretionary characteristics such as gross investment returns, risks, and regulations,” the researchers said. “At the same time, S&P 500 funds can charge different fees, and so can have heterogeneous net returns.”

To determine the level of complexity in fund disclosures, the researchers looked at four measures of readability in fund prospectuses: the length, determined for both the whole prospectus and the summary expense disclosure; words per sentence, also measured for the entire prospectus and the expense disclosure; the number of funds included in a single prospectus; and repetition of language from the details section of the prospectus in the summary section.

The researchers found that the sample funds had similar pre-expense returns, with the average tracking error clocking in at just 3.5 bps. But the within-year standard deviation of fees was much wider at 51 bps, consistent with funds charging different fees.

Based on subsequent statistical analyses and regressions, they confirmed a positive association between high fund fees and high “narrative complexity” – that is, the length and word density within a fund’s disclosure. They also found that funds whose disclosures had high structural complexity – those with more funds within a single prospectus and with more repetitive language – also tended to have high fees.

The researchers also looked at the role of marketing, with the expectation that fund managers use aggressive marketing in addition to having highly complex disclosures to obscure high fees. “As expected, we find positive associations between marketing and both narrative complexity and structural complexity,” the researchers said.

However, they stopped short of saying that mutual-fund firms are purposefully using wordy and confusing language to hide high fees. “[I]t is possible that the managers of high-fee funds do not realize that unnecessarily complex disclosures obfuscate fees,” the researchers said. “That said, our findings do indicate that managers of high-fee funds have not embraced the [U.S. Securities and Exchange Commission’s] repeated efforts to reduce mutual fund disclosure complexity.”


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