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Business Day
Why Are Mutual Fund
Fees So High? This Billionaire Knows
By
LANDON
THOMAS Jr.
DEC.
30, 2017
![](NY%20Times%2020171230%20Baron%20x40.png)
Ronald S. Baron, the founder of
Baron Funds, at his annual conference in New York last month.
“If you want the lowest fee, you should not invest with us,” he
said in an interview, arguing that his skills and experience
justify his costs.
Baron Funds |
The billionaire investor Ronald S. Baron flashed the grin of a proud
father at his annual investor jamboree in November, as the chief
executives of his favorite companies explained how slashing prices
stoked their bottom lines.
That is,
until a shareholder in one of his mutual funds drew an awkward
parallel.
“Excuse
me — Schwab is charging a very low fee,” a woman pointed out, after a
presentation by Walter W. Bettinger II, the chief executive of the
discount broker Charles Schwab. “God bless him, but no one ever said
Baron’s fees are little.”
You can
say that again.
Mr.
Baron’s mutual funds charge some of the higher investment fees around,
and the fees have held steady despite a $1 trillion exodus out of
old-school mutual funds into cheaper, better performing rivals that
track a variety of indexes and investment styles.
In a
global economy where competition and Amazonian price destruction have
forced companies to cater to cost-wary customers, the mutual fund
industry is a rare outlier. Fees on most actively managed mutual
funds, which house the retirement savings and other assets of millions
of Americans, have barely budged.
The
reasons for that — quiescent mutual fund boards, complacent investors
and a general unwillingness to call a halt to one of the great gravy
trains in financial history — are all visible inside Mr. Baron’s fund
family.
The
Baron Funds group manages $26.4 billion in assets on behalf of
hundreds of thousands of small and large investors. An old-fashioned
stock picker, Mr. Baron achieved renown in the 1990s and the 2000s for
successfully betting on small companies.
But his
performance has suffered in recent years. In 2014, 2015 and 2016, his
flagship fund, Baron Growth, trailed the Standard & Poor’s 500 stock
index by an average of seven percentage points.
This
year, the results have been better: He is up 27 percent, compared with
20 percent for the S. & P.
The 13
Baron funds impose fees that were 54 percent higher than last year’s
industry average — and vastly higher than what a comparable
exchange-traded fund would charge.
In
November, Baron reduced fees on three of its smaller funds. But the
largest, Baron Growth, with $6.3 billion in assets, still charges 1.3
percent of assets. That is a third higher than the median level for
similar funds, according to Morningstar.
Since
2010, investors have withdrawn, in net terms, just over $5 billion
from the growth fund, according to Morningstar. But many have stuck
around.
Mr.
Baron, 74, is perhaps best known for his annual investment conference,
now held at the Metropolitan Opera House at New York’s Lincoln Center
and in its 26th year. Mixing rock stars, pop entertainment (Barbra
Streisand and Paul McCartney have performed in the past), patriotism
(this year celebrated the 100th anniversary of President John F.
Kennedy’s birth) and triumphant chief executives, the gala is a giddy
ode to American capitalism.
Few fund
companies offer a comparable perk, and some 5,000 Baron fund holders
travel to New York to attend.
At the
conference in November, with markets hitting new highs each day,
investors were exultant. But there was a lingering concern.
“The
fees are very high,” one man said to a friend as they exited the Chris
Rock comedy show. “You really have to have the market go up to do
well.”
Even
longtime fans acknowledge they are paying up.
“I won’t
say performance warrants the fees they charge,” said Barry Edelman, a
Las Vegas retiree and a 20-year Baron shareholder. “But I appreciate
how they differentiate themselves from the competition.”
When the
shareholder asked Mr. Baron why his rates were so much higher than
Schwab’s, the audience response was telling: The opera hall erupted in
sympathetic laughter — and applause.
Mr.
Baron has been getting flak for his funds’ high costs for years.
“They
will always be expensive,” said Christopher Franz, an analyst at
Morningstar,
which won’t give the fund its highest rating because of the steep fees.
Baron’s Reasons
Mr.
Baron is unapologetic about the high fees. He argues that his skills
and experience — and the arduous task of researching small growth
companies — justify the fees.
“Since
inception, 98 percent of our funds have beaten their benchmark,” he
said in an interview. “If you want the lowest fee, you should not
invest with us.”
But if
you want to bet on American growth stocks, “you can double your money
in 10 years,” he said. He frequently sticks with his top picks for
decades.
While
this year has been stellar, over a longer stretch his performance is
less robust.
For a
five-year period, Baron Growth is up 13 percent, but
the iShares Russell 2000 Growth fund,
an exchange-traded fund that tracks Mr. Baron’s preferred benchmark
index, is up 15 percent. And iShares carries a fee of just 0.24
percent — a sliver of what Mr. Baron charges.
Mr.
Baron believes that the true measure of his success is performance
since his fund’s launch in 1994. A $10,000 investment in his main fund
then would be worth $163,207 today, according to Baron data. That
compares with $57,889 for the Russell growth index and $84,904 for the
S. & P. 500, per Baron.
Mr.
Baron’s funds are not the only ones refusing to budge on fees. In
fact, the average fee for 2,000 actively managed mutual funds has
remained 0.84 percent of total assets for the past three years,
according to Morningstar.
Some,
like the Capital Group and Fidelity, have gotten the message and have
reduced their fees over this period.
Industry
experts say there are several reasons that active mutual fund fees
have not succumbed to broader pricing trends in the economy.
![](NY%20Times%2020171230%20Baron%20conference%20x40.png)
Investors at Mr. Baron’s
conference. His funds are not the only ones refusing to budge on
fees: The average at 2,000 actively managed funds has remained
0.84 percent of total assets for three years, according to
Morningstar.
Baron Funds |
The
first is their power. While more than $1 trillion has left higher-fee
funds in favor of passive competitors, that still leaves some $10
trillion. That generates about $100 billion in fees for fund
companies. And it suggests they don’t need to cut fees to retain
assets.
It’s
dizzyingly complicated for investors to figure out what fees they’re
paying. With funds’ multiple share classes, varying structures and
oceans of boilerplate, even sophisticated investors may not realize
they are paying up for a laggard.
Board Oversight
Another
reason for elevated fees, experts say, is lax oversight.
Every
mutual fund is overseen by a board of trustees — a mix of executives
from the fund company and mostly independent officers that must, by
law, look out for investors’ interests.
But are
these boards truly effective advocates for investors?
A number
of lawsuits brought against major investment companies, including Axa,
BlackRock and Pimco, allege that trustees are not pushing hard enough
for lower fees. The judge overseeing the BlackRock case in 2015
declined to dismiss the suit, saying the allegations raised questions
about “rubber stamping” by boards.
BlackRock has said the suit lacks merit.
At the
Baron fund family, the fee oversight is complicated by the fact that
Mr. Baron, the largest shareholder in the investment company and the
manager of its largest fund, has a financial incentive to keep fees
high. In addition to his salary and bonus, tied to performance among
other measures, he gets a reward based on a percentage of the fees his
funds bring in, according to regulatory filings.
That is
unusual. At most fund companies, compensation packages reward managers
for beating their benchmarks — not collecting fees.
“Compensation based on fees is worrisome,” said Linlin Ma, an
economist at Northeastern University and a co-author of
a recent paper that examined incentives for mutual fund managers.
“That means that the portfolio manager will spend more time increasing
fees and the result is worse performance.”
William
A. Birdthistle, a former mutual fund lawyer and the author of a
book that examines the inner workings
of the fund industry, argues that one of the reasons some fund boards
are not more aggressive about pushing for lower fees is that trustees
tend to be closer in outlook and sympathy to the fund company that
hired and pays them. Often, they carry thin credentials and have
served on these boards for decades.
While
the average age for independent mutual fund directors is 66, some
directors stay on boards into their 80s and even 90s. Such long
tenures often make directors weak voices for investors, he said.
Baron
funds are overseen by nine directors. Seven are listed as independent.
Four of those seven have served as trustees since Mr. Baron
established his first funds 30 years ago.
One of
them, David A. Silverman, has zero financial experience: He is a
doctor with an expertise in infectious diseases.
The lead
independent trustee, Raymond Noveck, worked as a managing director at
Baron from 1985 to 1987.
“Trustees have very little incentive to fight managers,” Mr.
Birdthistle said. “Kicking and scratching is unlikely to lower fees
but certainly will antagonize the manager, which is the one
institution that can arrange for the trustees’ dismissal. Besides,
trustees will tell themselves, if a fund’s fees really are too high,
the market will sort things out and investors simply won’t invest in
the fund.”
The
board has taken steps to recruit trustees with bulkier backgrounds,
most recently Tom Folliard, a former chief executive of CarMax.
In a
statement, Baron Funds said that it regularly assessed its board’s
effectiveness and that the long tenure of some members was a sign of
the board’s experience and expertise. It said fees were approved via
data and analysis from an outside party. The board also said it was
represented by an independent lawyer.
One
clear winner of this arrangement is Mr. Baron. “In 1970, my net worth
was minus $15,000,” he said in the interview. “Now my children and I
have over $670 million invested in our funds.”
Forbes
pegs his wealth at just over $2 billion — and he is not shy about
showing it off.
His
office in Manhattan’s General Motors Building is a museum of trophies
and curiosities, from paintings by Andy Warhol and Roy Lichtenstein to
Kennedy’s rocking chair. He has invested about $150 million in a
59-acre beachfront estate in East Hampton, N.Y., that he bought in
2007.
Mr.
Baron’s investment philosophy — that over the long term the stocks
that he picks will keep doubling — is fired by a relentless optimism
that he attributes to his life’s good fortune.
A
grandchild of immigrants from Poland and Russia, Mr. Baron grew up
scraping for extra cash in Asbury Park, N.J. He worked his way through
college and law school, which he left without getting a degree.
In 1982,
after a stint as a Wall Street analyst, he founded his investment
firm.
His
timing was perfect. It was the start of a bull market, and he
developed an expertise in picking small companies that would grow into
big ones such as Charles Schwab, Vail Management Company and Tesla.
It was
the heyday of the individual stock picker. Peter Lynch at Fidelity and
Bill Miller at Legg Mason gained cultlike followings, accumulating
billions of dollars in assets and gracing the covers of the personal
finance magazines that lionized them.
Star Power
Mr.
Baron’s star power was of a lesser variety, but it was not
insubstantial. He became a regular television commentator and won a
reputation as the longest of long-term investors, holding positions
for decades. His assets peaked at $28 billion in 2015.
“We have
made $23.6 billion for our clients,” Mr. Baron said.
Mr.
Baron cultivates an intimate relationship with his investors; many
have been with him since the beginning. His
investment letters are rich with personal details as well
as his market views.
But it
is his annual investor gala, which he pays for himself, that defines
him. Onstage, he cultivates a grandfatherly mien, bragging about how
much money the chief executives of his portfolio companies made for
Baron shareholders. His chief maxim is “We invest in people,” and he
treats management as family.
There
are warm bear hugs onstage for some. Others get personal advice.
Spotting
a top executive from the data firm FactSet, another portfolio holding,
he offered to connect her with his longtime tax lawyer. “It’s
incredible what he has done,” Mr. Baron said.
A
surprise raffle is part of the atmospherics, and this time a Model 3
from Tesla was the grand prize. Tim McGraw and Faith Hill performed.
As the
event ended, attendees streamed out of Lincoln Center into a freezing
evening. Mr. Baron, without a coat, greeted them on the plaza. He
hugged and kissed old friends and posed for selfies with new ones.
Nobody
complained about the fees.
Correction: December 30, 2017
An earlier version of this article misstated how the iShares Russell
2000 Growth fund performed over a five-year period. It is up 15
percent, not 96 percent.
A version of this article appears in print on December 31, 2017, on
Page BU1 of the New York edition with the headline: Mutual Funds Are
Sticking To High Fees.
© 2017 The
New York Times Company