Fidelity Cuts Fees on Funds

Mutual fund giant Fidelity Investments turned the debate over industry fees up another notch Tuesday by slashing shareholder costs on five of its stock market index funds.

The move is a direct challenge to other fund companies and also to so-called exchange-traded funds, the low-cost stock portfolios that have become popular with investors in recent years.

Boston-based Fidelity said the annual expense ratio of its Spartan 500 Index fund, which tracks the blue-chip Standard & Poor’s 500 index, would fall by nearly half, from 0.19% of assets to 0.10%.

The expense ratio is the proportion of fund assets used to cover the costs of running the portfolio and can vary widely from fund to fund.

Fidelity also cut the management fee on the retirement-plan version of the Spartan 500 Index fund 50%. And it pared back the expense ratio to 0.10% on its Spartan-brand funds, which track the broader Wilshire 4,500 and Wilshire 5,000 indexes, and on its international index fund.

Mutual fund fees have come under a spotlight in the wake of the industry’s scandals over the last year.

New York Atty. Gen. Eliot Spitzer, who last September exposed widespread trading abuses in fund shares, has contended that fees charged by many fund companies are indefensibly high. Several of Spitzer’s settlements with fund companies over improper trading allegations have included agreements by the firms to reduce shareholder fees.

Fidelity -- which hasn’t been implicated in the trading scandal -- didn’t make its decision in response to the industry’s image problems over fees, said Jeff Carney, president of the firm’s personal investment arm.

He said Fidelity had been making an “aggressive effort” over the last 18 months to lower shareholder costs on various investments and services in an effort to lure investors from competitors.

Assets in Fidelity’s stock index funds total about $40 billion, and “we’d like to have more of that,” Carney said. The company manages more than $1 trillion in all.

By contrast, arch-rival Vanguard Group has about $300 billion in index-fund assets and manages about $730 billion in all.

Fidelity’s expense-ratio cuts, amid the uproar over industry fee levels, put many of its rivals in an awkward position, said Geoff Bobroff, head of fund research firm Bobroff Consulting in East Warwick, R.I.

Investors in other stock index funds, particularly those that track the S&P; 500, may wonder why they’re paying substantially more for the same basic product, Bobroff said.

Including marketing fees and broker-servicing costs, some S&P; 500 index funds take more than 1% of assets for expenses each year. That cost is deducted directly from shareholders’ returns.

The Securities and Exchange Commission is known to be looking at whether some index funds charge excessive fees.

With the fee reductions Fidelity announced Tuesday, its Spartan 500 Index fund undercuts even the industry’s perennial low-cost leader, Vanguard.

The Vanguard 500 Index fund available to retail investors charges an annual management fee of 0.18% of assets. However, the Vanguard fund’s minimum initial investment is $3,000. The Spartan funds have a $10,000 minimum.

Vanguard still holds the cost advantage in one version of its S&P; 500 index fund for retirement savings plans, such as 401(k) programs. That fund, Vanguard Institutional, charges a management fee of just 0.05% of assets.

Although fee reductions measured in tenths of a percentage point may not seem significant, over time they can mean far more money left in shareholders’ accounts, as opposed to in the pockets of fund companies, analysts note.

Lower fund fees also may become more important if stock market returns overall are sub-par in the next few years.

Fidelity’s Carney said the company would lose money on the index funds at the reduced fee levels, but he said the company believed the losses would be made up by additional business Fidelity expected to draw in from new index fund investors.

Indeed, Fidelity now may be better able to pitch its index funds as “core” investments for retirement accounts, said Russ Kinnel, director of fund analysis at fund tracker Morningstar Inc. in Chicago.

“I think this is aimed at 401(k) plans,” Kinnel said. If a company decides to offer Fidelity index funds to employees in its 401(k) plan, it may also offer other funds on which Fidelity earns far higher management fees, he said.

Lower fees on the index funds also will make them more competitive against exchange-traded funds.

Exchange-traded funds mimic index mutual funds but trade like regular stocks, and can even be sold “short” (a bet that they will decline in value). Many have rock-bottom portfolio management fees, in some cases less than 0.10%.

Total ETF assets soared from $66 billion in 2000 to $172 billion as of July, but Fidelity has not been a player in that market, Kinnel said.

Fidelity said the fee cuts on the five index funds would remain in place indefinitely. The company had raised fee levels on two of the funds in 2002, after launching the portfolios in 1997 at lower expense ratios.

Carney said it would take a “fairly material” change in the company’s business for it to shift direction and raise fees from the new levels.

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Fee sampler

Here is a sampling of annualized expense ratios of stock funds that track the Standard & Poor’s 500 index.

*--* S&P; 500 fund Fund company expense ratio AIM Invesco 0.65% Cigna 0.60% Dreyfus 0.52% TIAA-CREF 0.42% E-Trade 0.40% Charles Schwab 0.36% Merrill Lynch 0.36% T. Rowe Price 0.35% Vanguard 0.18% Fidelity Spartan 0.10% Vanguard Institutional 0.05%

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Sources: Morningstar Inc., Times research