Unbundling the Expense Ratio: Hidden Distribution Costs in European Mutual Fund Markets

AuthorGiacomo Nocera,Marco Navone
Date01 September 2016
Published date01 September 2016
Unbundling the Expense Ratio:
Hidden Distribution Costs in
European Mutual Fund Markets
Marco Navone
University of Technology Sydney, Business School, Ultimo NSW 2007, Australia
E-mail: marco.navone@uts.edu.au
Giacomo Nocera
Audencia PRES LUNAM, Centre for Financial and Risk Management, 8 route de la Joneli
ere, Nantes,
44312, France
E-mail: gnocera@audencia.com
Using data on more than 5,000 mutual funds domiciled in four European countries
in 2006, we investigate whether distribution costs embedded into the expense ratio
can be held responsible for the differences of expense ratios of mutual funds in
different countries. We conf‌irm the existence of relevant country effects in the
pricing of mutual fund management services. Comparing load and no-load funds
and using survey data on fee retrocession to the distribution channel, we provide
evidence that these effects are heavily inf‌luenced by the cost of the distribution
embedded in the expense ratio.
Keywords: mutual funds, expense ratios, distribution costs
JEL classification: G11, G23
1. Introduction
A recent empirical stylised fact d ocumented by academic researc h on mutual fund
fees is the presence of relevant count ry effects not fully explained b y observable
The authors thank an anonymous referee for constructive and extensive comments. They
also thank John Doukas (the Editor), Andrea Beltratti, Donato Masciandaro, Marco Onado,
Andrea Resti, Alessandro Rota, and other participants at the Paolo Baffi Centre Seminar at
Bocconi University (Milan), Apostolos Kourtis, and other participants at the Financial
Engineering and Banking Society Conference (Paris), Emilia Garcia-Appendini, Giovanni
Puopolo, and Gerry Drives for helpful comments and suggestions. Finally, the authors
would like to thank Clara Galliani for excellent research assistance. All errors remain those
of the authors. Financial support from the Paolo Baffi Centre of Bocconi University is
gratefully acknowledged.
European Financial Management, Vol. 22, No. 4, 2016, 640666
doi: 10.1111/eufm.12078
© 2015 John Wiley & Sons, Ltd.
differences (such as size, co ncentration and maturity) in t he national asset
management industries. K horana et al. (2009) show that, depe nding on the country
where an investor lives, the pr ice paid for a similar mutual f und can be 100 basis
points higher or lower. The aut hors try to reconcile these di fferences showing that
factors such as the investor protection guaranteed by the national regulations and the
sophistication of the aver age mutual fund investor, af fect the cost of investing in
mutual funds. They also f‌ind that less obv ious factors (such as the concentr ation of the
national banking industry) play a role. They f‌inally show that these effects may persi st
even among highly integrat ed national f‌inancial systems, such as most of the Europ ean
In this paper we argue that the analysis of these country effects is made harder by the
fact that in many countries management and distribution costs are bundled together with
production costs (portfolio management, administration, etc.) in a unique measure of
annual operating expenses, the so-called expense ratio, and cannot be observed
separately. Using a sample of 5,357 mutual funds registered in four European countries
(France, Germany, Italy, and United Kingdom) in 2006, we conf‌irm the existence of
relevant country effects and show that they are largely due to differences in the national
costs of mutual fund distribution services.
According to Cerulli Associates (2005), mutual funds in the four countries analysed
are sold through a signif‌icantly different mix of distribution channels: for example,
independent f‌inancial advisors account for 47% of the market (measured on the total
assets under management) in the UK, while they account only for 4% in the French
market (9% in Italy and 11.4% in Germany). Similarly, the Italian market is found to be
dominated by commercial banks that distribute 65% of the funds (but only 28.2% in
France and 8% in UK). Lastly, charity/endowment organisations and corporate divisions
managing pension obligations account for 26% of the French market, but are absent in
Italy and Germany.
Such a different channel mix is bound to generate different distribution costs
regardless of what happens on the production side of the national asset management
industries. Where distribution costs are paid separately from the expense ratio, we can
easily compare production costs of mutual funds across different countries, but, when all
the cost components are lumped together, it is harder to evaluate the ability of investment
companies to produce managed portfolios competitively. This opacity is generated by
the common practice in Europe to remunerate the sales channel not only through explicit
one-time fees like front- and back-end loads, but also through the retrocession to the sales
channel of a portion of the management fee. A periodic remuneration of the sales channel
is not unknown in the US experience, but in that setting an explicit fee, the so-called 12-
b1 or distributionfee, is charged, whereas the same information is kept conf‌idential in
As anecdotal evidence, it is interesting to mention that the Investment Funds Institute
of Canada formally complained to the authors of Khorana et al. (2009) about the reported
evidence of Canada having a more expensive asset management industry with respect to
a large sample of other countries. Among other issues, the complaint stated that: Recent
research conducted in the Canadian funds market showed that 85% of Canadian
investors purchase their funds through an advisor [...] The greater use of advisors by
Canadian investors compared to the United States leads to a very different mix of
business and price structure.And also that: It is very rare in Canada for additional fees
to be charged over and above the MER [expense ratio, authorsnote] by either the fund
© 2015 John Wiley & Sons, Ltd.
Unbundling the Expense Ratio 641

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