Mutual Fund Operating Expenses and Strategies

A mutual fund may use a percentage of its assets to pay fund expenses.   This percentage is typically limited (or capped) to maintain a fund expense ratio that is fair to shareholders and can compete in the market.  The following summary is designed to help an adviser considering launching a mutual fund, understand fund operating expenses and variables that could impact those costs.

Advisory Fees

The advisory fee is the fee paid to the adviser for managing the assets of a fund.  While an expense to the fund, advisory fees are revenue to the adviser. If the adviser also sponsors the mutual fund, which is very common, the adviser receives the revenue from the advisory fee but is also responsible for paying fund expenses that exceed the cap.  In this scenario, the adviser typically waives a portion, or all, of its fee to pay the excess.  If that does not cover the overage, the adviser pays the remainder out-of-pocket.

Advisory fees are asset based fees and may include breakpoints if the fund reaches scale.  For more information on factors to consider when determining your advisory fee, see our Advisory Fees and Expense Caps blog.

Other Annual Operating Expenses

• Fund administration is a broad term that covers a number of mutual fund services, often provided by a third-party fund service provider such as Apex Fund Services.  Fund administration services typically include: performance reporting; post-trade compliance; expense accounting, legal and regulatory support; financial reporting; and tax services.  Fund accounting may also be categorized within fund administration but is typically a separate line item on a fund’s statement of operations.  Administration and fund accounting fees are typically asset based with either a base or minimum fee.
• Transfer agency and shareholder recordkeeping services are also typically provided by a third-party administrator who is registered as a transfer agent with the SEC.  Transfer agency fees are based on the number of shareholder accounts in a fund and may have a fixed base fee or minimum and small asset based fee.  Transfer agency out-of-pockets are the costs of materials required to service the accounts, i.e., paper stock, ink and postage to prepare and mail transactions confirmations and statements, bank accounts, etc.
• Custody fees are paid to the fund’s custodian for holding fund assets.  Fees typically include asset based fees and transaction fees which vary based on the market where the security is traded.
• 12b-1 fees are asset based fees that can be used to pay fund sales and marketing expenses, pursuant to a 12b-1 plan. Absent a 12b-1 plan, funds are not permitted to pay for sales and marketing expenses.  Fees are typically a fixed asset based fee, e.g., investor share classes often charge a 25 basis point 12b-1 fee.
• Shareholder servicing payments are amounts that may be paid to fund intermediaries, such as Schwab and Fidelity, for providing sub-transfer agency services to the accounts held at an intermediary.  Shareholder servicing payments may be asset based fees, account fees or a combination of both.
• Legal fees are paid for legal services provided to the fund and independent trustees.  Funds may retain outside counsel to review fund filings, address fund matters and advise the trustees.  Fees may be a retainer or time and materials.
• Audit fees are paid to the fund’s independent accountant for performing the annual audit of the fund’s financial statements and tax returns.  Fees are approved annually by the board of trustees and are typically a fixed amount or a fixed amount plus out-of-pocket expenses.
• Blue Sky registration fees are paid to states to permit the sale of fund shares.  Each state has a different fee structure.  States may charge at the trust, prospectus, fund or share class level.  States may charge fixed fees or asset based fees, with or without minimums or caps.  The process to register in a state typically takes three to five days, therefore it is common for funds to only register in the states where they’re sold to limit Blue Sky fees.
• Shareholder reporting and printing are the costs of typesetting, printing and filing, via EDGAR, shareholder reports, including the fund’s registration statement and financial statements.  Costs vary based on the style of report selected, i.e., black and white vs. color, paper quality, etc., and number of materials printed.
• Trustee fees are the fees paid to the trust’s independent trustees for providing oversight.  Fees vary but typically have a fixed or retainer component and may include additional fees per meeting plus out-of-pocket expenses for board meeting travel and accommodations.
• Insurance expense is the cost of insurance for the trust’s Directors and Officers/Errors and Omissions (D&O/E&O) coverage and fidelity bond.  D&O/E&O premiums are based on coverage limits and deductibles.  Fidelity bond coverage is fixed based on fund assets.
• Pricing costs are paid to third-party data vendors for providing daily, market close prices.  Costs vary by security type.
• SEC registration fees are paid on net new sales pursuant to a fund’s 24f-2 filing which includes information about a fund’s securities sold and redeemed.
• Miscellaneous or other fees, as the name suggests, are fees that do not fit in any of the above categories.  Examples of such fees include security indicative data, benchmark licenses, NASDAQ fees per share class, peer report comparisons, costs associated with preparing board materials, etc.

Accruing and Paying Fund Expenses

Mutual fund expenses are accrued daily and impact a fund’s net asset value.  The fund administrator pays fund expenses including the adviser, who is paid monthly.  If a fund is operating above its cap, the fund administrator will deduct the amount of expenses above the cap from the advisory fee, prior to payment.  If the expenses that exceed the cap are greater than the adviser’s fee, the adviser will reimburse the fund for those expenses.  If the fund is operating below its cap, the adviser receives its full fee, and, if the adviser has waived or reimbursed fees within the last three years, the adviser may recoup the difference between the actual expense ratio and the expense cap.

Controlling Fund Expenses

As with any company, expense management is an important aspect of optimizing revenue.  The above fees are all necessary to operate a mutual fund however there are ways an adviser can manage expenses.  A series or shared trust allocates trust level expenses, such as trustee fees, insurance and certain legal costs, across funds, which can provide significant savings.  There are pros and cons to using a series trust versus sponsoring your own trust (stand-alone trust), namely cost versus control, which require careful consideration.  A fund administrator can guide you through the benefits and drawbacks of each.

As noted above, limiting Blue Sky state registrations to only the states where the fund is sold, as opposed to registering in all states in advance of sales, can provide meaningful savings.  Using your administrator’s legal department to prepare draft filings and assess questions or matters before reaching out to fund or trustee counsel, will help maintain fund legal costs.

While there is a limit to expense management, your fund administrator can play a critical role in helping you understand fund expenses and providing expense management strategies.  To learn more about fund operating expenses and expense management strategies, please contact Jessica Chase at 207 347 2016 or submit an inquiry via Contact Us.