Index funds sold by brokers in the United States are significantly more expensive than true no-load funds, according to a new study by the Zero Alpha Group and Fund Democracy.

The study argues that investors who buy index mutual funds through brokers are paying a steep “broker penalty” by being sold funds with much higher operating expense fees even before adding the distribution fees related to the cost of using the broker.

“The extra operating costs paid over time for broker-sold load index funds are triple those paid by investors in true no-load mutual funds,” it said.

The study found that true no-load fund investors pay no distribution expenses and an average of 21.5 basis points in operating expenses, no-load fund (12b-1 fee/no commissions) investors pay 12.6 basis points in distribution expenses and 31.8 basis points in operating expenses. Load fund investors pay 15.6 basis points in distribution expenses and 70.4 basis points in operating expenses, which means that in return for an additional 15.6 basis points worth of distribution services they pay an extra 48.9 basis points for operating services over the amount true no-load investors pay, it found.

The study concludes that the use of a broker results in investors being placed in higher cost funds – in effect, the imposition of a ‘broker penalty’ – even after excluding the cost of the broker’s services.

“Although one would expect using a professional adviser to improve an investor’s performance, instead the investor pays a significant penalty,” it finds. “We found that load index funds charged substantially higher fees – even before counting the fees paid to the broker – than true no-load (no 12b-1 fee) funds. In other words, when investors used brokers they paid twice: first, they paid the broker; second, they paid a broker penalty in the form of higher fund fees.”

The research, authored by Edward O’Neal, assistant professor, Babcock Graduate School of Management, Wake Forest University and Fund Democracy president Mercer Bullard, finds: on a US$10,000 investment earning an annual return of 10% over 20 years, the average investor in no-load, no 12b-1 fee index funds would pay approximately US$2,582 in operating expenses. The average investor holding a no-load fund that charges a 12b-1 fee would pay US$3,744, while the average investor holding load index funds would pay US$7,600 in operating expenses.

Bullard, president and founder, Fund Democracy, said, “Brokers are supposed to work for their clients, but when recommending a generic product such as an index fund, they refer their clients to more expensive funds and then collect sales charges to boot. Federal law requires that brokers charge the commissions that funds tell them to charge. It is time to end price fixing in the fund industry and cut the cord between mutual funds and the brokers who sell them.”

The ‘broker penalty’ observed in the ZAG/Fund Democracy study more than doubled when the analysis was asset-weighted, it said. “That is, when fund expenses were weighted by the amounts actually invested in different funds, the true no-load investor paid an average of 21.5 basis points in operating expenses, in comparison with the load investor’s average operating expenses of 70.4 basis points,” it reported.