Shares in mutual fund companies take off
— -- Wall Street has many fascinating proverbs, such as "Don't catch a falling knife," "Let your winners run," and, "An auditor can never be too drunk."
But here's one that bears examining: "When everyone else is looking for gold, it's good to be in the pick and shovel business."
In a bull market, it's good to be in the mutual fund business.
Shares of publicly traded fund management companies — the companies that run the funds, not the funds themselves — have soared 54% this year, vs. 5% for the Standard & Poor's 500-stock index. Are there any cheap fund-company stocks left? Yes, but you might be better off investing in companies that distribute funds, rather than companies that manage them.
Fund management companies earn their profits by taking a percentage of a fund's assets each year. Funds call that percentage the "expense ratio." The typical expense ratio for large-company core stock funds is about 1.2%, according to Lipper, which tracks the funds. Last year, the five largest stock mutual funds raked in about $2.2 billion in expense fees. At least someone did well last year.
A bull market has two other happy effects for fund management companies. First, a rising market increases the value of the funds' securities, which, in turn, means more income from expense fees. Consider a $1 billion fund that gains 30% in the course of a year. The fund charges 1.5% in expense fees. Management's take from the fund jumps 30%, to $19.5 million from $15 million.
The second happy effect: Investors shower funds with money during a bull market. A top-performing fund might see its assets double in a good bull market year, thanks to investment gains and new investor money. In that case, its income from expense fees will double, too.