Mutual funds' business model is simple: In return for managing their pool of investments on your behalf, they collect a percentage of your holdings each year in expenses. But a handful of funds now offer annual fees of 0% -- or in some cases, negative fees that actually pay you to invest!
This new wrinkle comes from Bridgeway Funds, a shop long known for its progressive ways. No partner earns more than seven times what the lowest-paid partner earns, and 50% of investment advisory fee profits donated to nonprofits. In addition, Bridgeway fund fees are linked to performance, rising in times of strong returns, and falling when returns are poor. Since some of their funds have slumped sharply in the past several years, the annual fee for the Bridgeway Aggressive Investors 1 (BRAGX) fund has fallen into negative territory, while the Bridgeway Micro-Cap Limited (BRMCX) fee recently reached 0%.
When free isn't so great
That may be tempting, but think twice. Fee-less-ness is nice, but not if a fund loses a lot of money. I like the integrity of the fund company, and I realize that many good funds experience a few bad years, but the fund's methods concern me. The Bridgeway funds rely heavily on quantitative models for their investment decisions. It may be that in certain kinds of markets, like the weird ones we've experienced lately, the models don't perform well.
For instance, the Aggressive Investors 1 fund lost more than half its value in 2008, greatly trailing the swooning market. Prior to that, in the fund's Dec. 31, 2007 semiannual report, management noted that its biggest loser was WellCare Health Plans (NYSE: WCG ) , the subject of fraud investigations, adding, "Unfortunately, our models can't identify issues like this before they happen." Making matters worse, the model had them hold on for several months after the bad news broke.
Also at the time, management praised its Crocs (Nasdaq: CROX ) holding's past gains for the fund, but noted poor performance in late 2007, not yet knowing that it would lose more than 95% of its value in 2008. (The stock has since surged, but not enough to make up for lost ground.) The fund cited the fact that "its future guidance on revenues fell short of expectations" and that it "had trouble keeping up with the increasing demand for its products throughout Europe and Japan." But its fad status isn't the kind of thing that quantitative models can dependably pick up.
Also praised were Apple and Research In Motion (Nasdaq: RIMM ) for their big returns in 2007. The fund opined, "Apparently there is room for both in this market." Research In Motion let the fund down, though, dropping more than 60% in 2008 as it struggled against the iPhone.
Don't rush into low or no fees without looking closely at a fund and its prospects -- unless you enjoy the idea of derailing your retirement.
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