Abstract
Using data collected from equity mutual fund reports filed by single-fund registrants to the Securities and Exchange Commission, I study the determinants of brokerage commissions paid by fund managers when they buy or sell securities and investigate the role these commissions play in fund performance. Consistent with related studies, my results from cross-sectional analyses reveal that higher portfolio turnover funds are associated with higher commissions and larger funds incur lower commissions, as well as the positive relation between expense ratios and commissions. This positive relation is puzzling as most commissions include “soft dollars” for payments of products and services that should be already covered by the costs reported under expense ratios. However, once I take into account unobservable fund heterogeneity, I find that higher expense ratio funds do not necessarily pay higher commissions. Further, controlling for whether a fund increased commission payments as the result of flow-induced trading, I show that the underperformance related to brokerage commissions documented in the literature is attributable (at least partly) to higher level of fund flows.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
A copy of the N-SAR questionnaire is available at http://www.sec.gov/about/forms/formn-sar.pdf
12b-1 fees are named after the SEC rule introduced in 1980 that allows funds to pay distribution expenses out of fund assets.
A load fund collects one-time fees from investors as a percentage of invested money to compensate brokers who sell the fund shares. Load charges may be incurred at the time of purchase, time of redemption, or a mix of both.
Routine inspections are to identify weaknesses in advisers’ internal controls and compliance to policies and procedures. Sweep exams are more focused examinations (e.g., on one issue of regulatory concern).
Post-Effective amendments filed pursuant to Rule 485(b) of the Securities Act, which provides for immediate effectiveness of amendments to a prospectus that make non-material changes.
A fund (e.g., Fidelity Magellan Fund) filed by a single-fund registrant may also be part of a fund family.
My sample is more restricted than that of Edelen et al. (2012) who study a total of 765 funds (7597 semiannual observations).
Moreover, in their analysis of commission bundling, Edelen et al. (2012) show that, results for single-fund and multi-fund registrants are similar.
Clifford et al. (2013) report an average of 4.65% (4.61 %) for monthly inflows (outflows) for a sample of equity funds over the period 1999 to 2009. At the 90th percentile, their sample monthly inflows (outflows) are 8.4 6% (6.93 %).
To make commission ratios comparable to expense ratios, I use Commission ratio rather than Commission rate (commissions as a percentage of total trade) in the models. Considering commissions as a percentage of current fiscal year TNA or as a percentage of average TNA, instead of a percentage of beginning-of-fiscal-year TNA, I find similar results.
Equity funds indicate their investment objectives in N-SAR filings. I control for such objectives only in OLS models because investment objectives are time-invariant, thus already controlled for in panel FE models.
In unreported tests, I include the square of Log size in the models to check for the possibility of diseconomies of scale with respect to commissions. None of the coefficients on the square of Log size are statistically significant.
One would expect that a fund that belongs to a fund family could benefit from some economies of scales in regard to commissions. However, while I include the In family dummy variable in my models, I have reservations about interpreting the related results because the reporting of this variable is not consistent in the N-SAR filings.
To make the models comparable with most mutual fund performance models, I use pooled OLS models here. Moreover, the Breusch-Pagan LM test null hypothesis cannot be rejected for each performance model, thus a panel model is less appropriate. Table 4’s R-squared are low, but higher than those of Edelen et al. (2012) in their Table 5 and Table 8.
References
Breusch T, Pagan A (1980) The Lagrange multiplier test and its applications to model specification in econometrics. Rev Econ Stud 47:239–253
Cameron CA, Trivedi PK (2009) Microeconometrics using Stata. Stata Press, TX
Carhart MM (1997) On persistence in mutual fund performance. J Financ 52:57–82
Chen J, Hong H, Huang M, Kubik J (2004) Does fund size erode mutual fund performance? The role of liquidity and organization. Am Econ Rev 94:1276–1302
Clifford CP, Fulkerson JA, Jordan BD, Waldman S (2013) Risk and fund flows. Working paper. SSRN: http://ssrn.com/abstract=1752362. Accessed 25 August 2013
Dellva WL, Olson GT (1998) The relationship between mutual fund fees and expenses and their effects on performance. Financ Rev 33:85–104
Dougherty C (2011) Introduction to econometrics. Oxford University Press, NY
Dukes WP, English PC II, Davis SM (2006) Mutual fund mortality, 12b-1 fees, and the net expense ratio. J Financ Res 24:235–252
Edelen RM (1999) Investor flows and the assessed performance of open-end mutual funds. J Financ Econ 53:439–466
Edelen RM, Evans R, Kadlec GB (2007) Scale effects in mutual fund performance: the role of trading costs. Working paper. SSRN: http://ssrn.com/abstract=951367. Accessed 12 March 2012
Edelen RM, Evans R, Kadlec GB (2008) What do soft-dollars buy? Performance, expense shifting, agency costs. Working paper. http://www.terry.uga.edu/finance/docs/edelen_soft_dollars.pdf. Accessed 12 March 2012
Edelen RM, Evans R, Kadlec GB (2012) Disclosure and agency conflict in delegated investment management: evidence from mutual fund commission bundling. J Financ Econ 103:308–326
Elton EJ, Gruber MJ, Das S, Hlavka M (1993) Efficiency with costly information: a reinterpretation of evidence from managed portfolio. Rev Financ Stud 6:1–22
Fama EF, French KR (1993) Common risk factors in the returns on stocks and bonds. J Financ Econ 33:3–56
Fama EF, French KR (2010) Luck versus skill in the cross-section of mutual fund returns. J Financ 65:1915–1947
Flannery MJ, Hankins KW (2013) Estimating dynamic panel models in corporate finance. J Corp Fin 19:1–19
Gao X, Livingston M (2013) Brokerage commissions: A hidden costs of owning mutual funds and the need for greater transparency. Working paper. http://www.fma.org/JAF2013/Papers/MF_BROKERAGE_COMMISSIONS.pdf. Accessed 5 December 2014
Gao X, Livingston M, Zhou L (2014) Brokerage commissions and mutual fund performance. Working paper. http://www.fma.org/Nashville/Papers/brokerage-FMA_2014.pdf. Accessed 5 December 2014
Hausman JA (1978) Specification tests in econometrics. Econometrica 46:1251–1271
Hooks JA (1996) The effect of loads and expenses on open-end mutual fund returns. J Bus Res 36:199–202
Horan SM, Johnsen DB (2004). Does soft dollar brokerage benefit portfolio investors: agency problem or solution? Working paper. http://www.law.gmu.edu/assets/files/publications/working_papers/04-50.pdf. Accessed 19 February 2012
Investment Company Institute (2010) Investment Company Fact Book. http://www.ici.org/pdf/2010_factbook.pdf. Accessed 19 February 2012
Karceski (2002) Returns-chasing behavior, mutual funds, and beta’s death. J Financ Quant Anal 37:559–594
Karceski J, Livingston M, O’Neal ES (2005) Portfolio transactions costs at U.S. equity mutual funds. Working paper, University of Florida
Livingston M, O’Neal ES (1996) Mutual fund brokerage commissions. J Financ Res 19:273–292
Prior A (2010) The hidden costs of mutual funds. Wall Street Journal.http://online.wsj.com/article/SB10001424052748703382904575059690954870722.html?mod=WSJ_hp_editorsPicks. Accessed 24 March 2012
Securities and Exchange Commissions (2006) Commission guidance regarding client commission practices under Section 28(e) of the SEC Act of 1934. http://www.sec.gov/rules/interp/2006/34-54165fr.pdf. Accessed 23 January 2012
Sharpe WE (1966) Mutual fund performance. J Bus 34:119–138
Wooldridge JM (2002) Econometric analysis of cross-section and panel data. MIT Press, MA
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Rabarison, M.K. New insights into mutual fund brokerage commissions. J Econ Finan 40, 492–513 (2016). https://doi.org/10.1007/s12197-015-9318-6
Published:
Issue Date:
DOI: https://doi.org/10.1007/s12197-015-9318-6