Index Fund Fingering

As the curiously low-profile investigation into mutual fund mismanagement proceeds apace, regulators are talking about more tightly policing differences in index funds, which seek to track large segments of a given industry or market measure (such as the S&P 500).

There's variance in the fees companies charge to maintain these funds, which are usually passively managed, meaning they don't really have hugely different cost structures to operate (unlike actively managed funds, where managers buy and sell a lot of stocks). From a NY Post account:

According to Morningstar, Inc., which monitors fund companies, the Vanguard 500 Index charges customers 0.18 percent of assets annually. But the Scudder S&P 500 stock fund levies as much as 1.8 percent as a fee.

"There can be quite a bit of difference. Whether there should be is an open question," said Jeffrey Ptak, a mutual fund analyst with Morningstar. "There isn't any reason I can think of."

One reason that should be sufficient is that investors knowingly tolerate such differences–Vanguard's low fees are its main advertising point. It may not be "rational" in any grand sense to buy an index fund with higher fees, but it's still meaningful to some people, especially when seemingly identical products may be subtly different. Why does anyone buy brand-name aspirin when generic is by most accounts just as good? There's a service component and a comfort component that is always highly subjective. Even when people may seem to be acting stupidly or wrongly (another subjective categorization), there's a lot to be said for letting them do so in consumer situations. Indeed, letting people spend their money the way they want to is basic to any free society.

But there's reason to believe that the focus on index funds–where nearly identical products are unders scrutiny–is really one more way to set the stage for more tightly regulating fees in mutual funds for more disparate products (fees are already heavily regulated, as is everything in the securities industry).

Why is it OK to set a rate for index funds, but it's not OK in other areas?" asked Geoff Bobroff, a mutual fund consultant with Bobroff Consulting. "It is one of those curious questions."