Greenberg: Wall Street’s Dirty Bond Fund Secret

Cash in a trap
Nicholas Eveleigh | Stockbyte | Getty Images
Cash in a trap

It’s no secret that bond funds are where the action has been over the past year, with most new fund money going their way.

What is a secret—or at least something that never gets discussed—is the cost of investing in bond funds.

On the surface, those expenses look reasonable: The average expense ratio of a short-term bond fund, according to Lipper, is 0.74 percent of the amount you’ve invested in the fund. (Short-term bond funds are collecting nearly one-quarter of all new bond-fund money, based on Investment Company Institute figures.)

Take a closer look: Lipper’s database shows the average total return on all short-term bond funds is around 2.21 percent. (On all funds, it’s 0.97 percent on year-to-date performance 4.24 percent.)

In other words, and this is the important part of this story: Relative to returns, not your percentage of the fund’s assets, the expense ratio on short-term funds is more like 34 percent (not 0.34 percent), which is more than you’d pay on the performance fee of a hedge fund.

Except most investors in hedge funds wouldn’t tolerate a 2.21 percent return, even if that were than the stock market. (And this calculation doesn’t include broker commissions.)

Companies with big bond fund exposure include BlackRock , Franklin Resources and PIMCO, which is part of AllianceBernstein . These companies either didn’t return our calls or declined comment. One top exec of a large bond fund company told me, “What’s the alternative—Treasuries? This isn’t a story.”

He added: “People don’t fee shop.”

My take: Maybe they don’t, but maybe they should. As fiduciary standards get tougher there are those in the industry who believe investment advisors may feel compelled to spell some of this out.

And there is chatter that the SEC may push to reduce or abolish the 12b-1 marketing fee. Loser if any of this happened would be the investment advisors, which is one reason money manager Doug Kass is short Franklin, Federated Investors, AllianceBernstein and T. Rowe Price ; winner, the investor.

"The Strategy Session," hosted by David Faber and Gary Kaminsky, airs weekdays at Noon ET on CNBC.

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