The Mutual Fund Marketing Machine: 12b-1 Fees and the Asset Gathering Game
Common Sense on Mutual Funds | John C. Bogle | ISBN: 9780470597484
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Marshall McLuhan said “the medium is the massage.” Bogle twists it for Chapter 16: in the fund industry, “the message is the medium.” Marketing shapes what funds offer and what they cost. The cart pulls the horse.
For the first 50 years after 1924, mutual funds focused on stewarding money. Advisers managed. Underwriters distributed. Many big fund companies didn’t even handle their own marketing. That changed fast.
Four problems with marketing obsession
- It costs billions. Marketing comes out of fund assets. Shareholders pay. Managers benefit.
- Growth hurts returns. More assets in a fund often means worse performance (Chapter 12).
- Investors get misled. Hot funds get hyped. Risks get hidden.
- Owners become customers. A fund stops being an investment account under professional management and becomes a product sold by a professional marketer.
Your money is no object (because it’s not theirs)
Fund managers may spend $10 billion a year on marketing. That’s more than the $3-4 billion spent on actual investment management. “Management” fees fund marketing campaigns.
The 12b-1 fee: Pandora’s box
Before October 1980, fund assets couldn’t be used for distribution. Sales loads (up to 8%) paid brokers. No-load funds disrupted that model.
The industry’s solution: replace a clear 6% front-end load with a blurry 1% annual fee plus a declining back-end load. The math didn’t quite work (rising markets made total costs higher), but it looked like no-load.
Then the SEC let 12b-1 fees become a simple add-on to any fund’s expenses. Even no-load funds could charge them. Pandora’s box opened.
By 1998, 7,000 of 13,000 funds charged 12b-1 fees. Total: $6+ billion per year. Average fee: 0.40% of assets. A fund growing from $500 million to $5 billion might see its expense ratio drop from 1.10% to 1.00% from economies of scale. Add a 0.25% 12b-1 fee and the new ratio is 1.25%. Net increase.
Bogle’s 2009 update: 12b-1 fees hit $28 billion. Still no evidence they help investors. The SEC couldn’t muster the courage to eliminate them.
Fund supermarkets: the croupier’s take
Shelf space in fund supermarkets costs 0.35% of assets acquired. The largest supermarket held $70 billion and collected ~$250 million per year from funds. “No-fee” for investors. Not no-fee for the fund’s existing shareholders, who pay whether they use the supermarket or not.
Bogle compares it to a casino. The croupier’s take grows as trading increases. Short-term traders win free switching. Long-term holders pay the bill.
A Harvard study found equity funds without 12b-1 fees outperformed funds with them by 1.5 percentage points per year. Bond funds with 12b-1 fees took more risk to compensate for the fee drag. Shareholders weren’t told about the trade-off.
Hawking products, hiding risk
When marketing drives product creation, you get garbage:
Government-plus funds (1987). Advertised 12% when Treasuries yielded under 8%. $30 billion lost. Gone.
Short-term global income (1989). Chased 10%+ yields. Returned 2% annually. Gone.
Adjustable-rate mortgage funds (1992). Returned 1.5% annually. Gone.
Three fads, three wipeouts. Great marketing. No apologies.
Owners vs. customers
Morningstar’s Don Phillips wanted fund prospectuses to start with: “When you buy shares in a mutual fund, you become a shareholder in an investment company.” The Investment Company Institute rejected it. The SEC agreed with the industry. “Owner” language isn’t required.
Bogle sided with Phillips. Calling investors “customers” of a “packaged product” erodes fiduciary duty.
Jason Zweig laid out 10 differences between a marketing firm and an investment firm at an industry dinner. He got hooted down by advertisers. Portfolio managers would have given him a standing ovation, he guessed.
The marketing firm incubates and kills funds. Charges flat fees as assets grow. Never closes bloated funds. Hypes tiny fund track records. Creates funds because they sell, not because they’re good. Pays managers based on asset flows. Doesn’t warn about risk.
The investment firm does none of that.
Goldman Sachs put it plainly in 1995: “Managing money is not the true business of the money management industry. Gathering and retaining assets is.”
My take
This is the angriest chapter in the book, and for good reason. Bogle watched the industry he helped build turn into something he didn’t recognize.
The 12b-1 fee is regulatory capture in action. Created for economies of scale. Became a permanent marketing subsidy. Still growing. Still benefits managers, not shareholders. Bogle’s collected quotes say it all: “Distribution is king.” Most investors don’t even know they pay fees.
For investors, the practical checklist from this chapter:
- Avoid funds with 12b-1 fees
- Be suspicious of funds pushed heavily in supermarkets
- Ignore ads showing “#1 performance” or steep mountain charts
- Treat new fund categories as marketing experiments, not investments
- Remember you’re an owner, not a customer
Bogle banned the word “product” at Vanguard when he founded it. That single choice says everything about how he saw the business vs. how the industry sees it now.
The 2009 update is bleak. Consumer advertising hit $1 billion in two years. New exotic products multiplied. ETFs became speculation vehicles. “We’ve moved a long way from our mission to serve investors.”
Twenty years later, that distance has only grown. But Bogle’s prescription hasn’t changed: management back in the driver’s seat. Make something good. Sell what you make. Put clients first.
Simple principles. Inflexible ones. Exactly what Lincoln and Bogle both demanded.