Mutual funds today manage $10 trillion in assets, more than the entire U.S. banking industry. Many Americans rely on mutual funds for their savings for retirement, college, and other long-term goals. Yet, as Competitive Equity argues, the current regulatory structure for mutual funds keeps costs for investors higher than they should be.
With thousands of individual mutual funds crowding the marketplace, competition among funds might seem robust. Yet the expense ratios charged by the highest-cost funds are about three times those of the cheapest--a clear signal that funds are not competing effectively on price. This is a serious issue because even small differences in price can deeply erode investment results over time.
Regulators have tended to believe this dynamic is the result of a fundamental conflict of interest between investment advisers and the funds they advise. Their preferred remedy has been ever-tighter regulation and greater independence for funds' boards of directors, which negotiate fees and expenses with the advisers.
Competitive Equity argues that the problem is not too little regulation, but too much and of the wrong kind. The authors show how current government regulatory policy leads to de facto rate regulation by fund boards. Acting remarkably like public utility commissions, boards today set fund fees on the basis of reported costs plus a "reasonable" profit, thus undermining advisers' incentive to aggressively cut costs and compete to lower prices.
To restore competition, the authors recommend the creation of a new, alternative legal structure for collective investment, the "managed investment trust," which could eventually supplant traditional mutual funds, creating a more vibrant marketplace for investors.
Peter J. Wallison is a senior fellow at the American Enterprise Institute, where he is the co-director of AEI's Financial Services Project on Financial Market Deregulation.
Robert E. Litan is vice president for research and policy at the Kauffman Foundation, a senior fellow in the Economic Studies and Global Studies Program at the Brookings Institution, and co-director of the AEI-Brookings Joint Center on Regulatory Studies.
Praise for Competitive Equity
"This book is essential reading for anyone who wishes to understand and evaluate the current regulatory regime in mutual funds market, and it will be invaluable in the classroom. A quarter century has passed since it was widely recognized that ill-considered legislation and regulatory rules, ostensibly adopted to protect consumer interests by encouraging competitive behavior, often do the opposite. Among the invaluable insights brought to our attention by this book is recognition that such an indefensible regulatory regime remains in the mutual funds industry. By enforcing what amounts to a cost-plus regime, the incentives for investment advisers to operate efficiently are undercut and price competition is impeded."