From 1980 to 2006, the U.S. financial services sector grew from 4.9% to 8.3% of GDP. A substantial share of that increase represented increases in asset-management fees.

Excluding index funds (which make market returns available even to small investors at close to zero expense), fees have risen substantially as a percentage of assets managed. In my judgment, investors have received no benefit from this increase in expense ratios.

The increase in fees could be justified if it reflected increasing returns for investors from active management, or if it improved the efficiency of the market. Neither of these arguments holds. Actively managed funds of publicly traded securities have consistently underperformed index funds—by roughly the differential in fees charged.

Passive portfolios that held all the stocks in a broad-based market index have substantially outperformed the average active manager since 1980. Therefore, the increase in fees likely represents a deadweight loss for investors.

There are substantial economies of scale in asset management. It is no more costly to place an order for 20,000 shares of stock than for 10,000 shares. The same annual report and similar filings to the Securities and Exchange Commission are required whether an investment fund has $100 million or $500 million in assets. The due diligence required for the investment manager is no different for a large mutual fund than for a small one. Modern technology has fully automated such tasks as dividend collection, tax reporting and client statements. Academic research has documented substantial economies of scale in mutual-fund administration.

Also In This Issue

Quarterly Review Of Capital Markets
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Recommended Investment Vehicles