Adjusted average expense

What Is Adjusted Average Expense?

Adjusted average expense refers to the calculated average of a fund's total operating expenses over a specified period, taking into account any fee waivers, expense reimbursements, or other adjustments made by the fund's advisor or management company. This metric is crucial within investment management as it provides investors with a more accurate representation of the actual costs they bear for holding a mutual fund or Exchange-Traded Fund (ETF). While a fund's stated expense ratio reflects its gross annual operating costs, the adjusted average expense reflects the net cost after temporary or contractual reductions. This falls under the broader category of financial analysis, offering a nuanced view of investment costs.

History and Origin

The concept of "adjusted average expense" largely evolved from the ongoing efforts to enhance transparency in fund fee disclosure. Historically, investment funds disclosed their total annual operating expenses as a percentage of assets, commonly known as the expense ratio. However, fund companies sometimes waive or reimburse certain fees to keep their costs competitive, especially for newer funds or those aiming to attract assets. Regulatory bodies, such as the U.S. Securities and Exchange Commission (SEC), have consistently pushed for clearer and more comprehensive disclosure of all costs associated with investment products. The SEC requires funds to provide detailed fee information in their prospectuses and shareholder reports, which includes both the gross expense ratio and, where applicable, the net expense ratio after waivers or reimbursements⁸, ⁹. This focus on the "net" or "adjusted" figure became more prominent as investors and regulators sought a truer picture of the ongoing costs.

Key Takeaways

• Adjusted average expense provides a more accurate reflection of the actual costs investors pay for a fund, accounting for fee waivers or reimbursements.
• It is a key metric in evaluating the long-term cost-effectiveness of an investment.
• Fee waivers and reimbursements, which lead to an adjusted average expense, can be temporary or contractual.
• Lower adjusted average expenses generally correlate with better investor total return over time, as fees have a direct impact on performance.
• Investors should compare the adjusted average expense of similar funds before making investment decisions.

Formula and Calculation

The adjusted average expense is primarily derived from the total annual fund operating expenses, net of any waivers or reimbursements. While there isn't one universal "adjusted average expense" formula, it commonly refers to the "net expense ratio" disclosed in a fund's prospectus.

The calculation for the annual adjusted expense rate is:

Where:

• Total Operating Expenses: All costs incurred by the fund for its operations, including management fees, administrative costs, and 12b-1 fees.
• Fee Waivers: Reductions in fees voluntarily given up by the fund's advisor.
• Expense Reimbursements: Payments made by the advisor to cover certain fund expenses, effectively reducing the cost borne by the fund.
• Average Net Assets: The average value of the fund's Net Asset Value (NAV) over the specified period, typically annually.

To calculate the adjusted average expense in dollar terms for a specific investment, one would multiply this adjusted expense rate by the amount invested over the period.

Interpreting the Adjusted Average Expense

Interpreting the adjusted average expense involves understanding its significance in the context of investment returns and long-term wealth accumulation. A lower adjusted average expense indicates that a smaller portion of the fund's assets is being consumed by fees, leaving more to compound for the investor. For instance, a fund with an adjusted average expense of 0.20% will generally provide a higher net return than a comparable fund with an adjusted average expense of 0.75%, assuming identical gross performance.

Investors should pay close attention to whether the reported adjusted average expense is "net" (after waivers) or "gross" (before waivers). The "net" figure represents the true cost paid by current shareholders. It is important to remember that fee waivers and reimbursements are often temporary, meaning the adjusted average expense could increase in the future once these agreements expire. This distinction is vital for accurate financial planning.

Hypothetical Example

Consider an investor, Sarah, who is evaluating two hypothetical index mutual funds, Fund A and Fund B, each tracking the same broad market index. Sarah invests $10,000 in each fund.

• Fund A has a stated gross expense ratio of 0.70%. However, its fund manager has contractually agreed to waive 0.20% of the management fees for the current year to attract new investors.
• Fund B has a stated gross expense ratio of 0.50%, with no fee waivers or reimbursements in place.

For Fund A, the adjusted average expense for the current year would be:
0.70% (Gross Expense Ratio) - 0.20% (Fee Waiver) = 0.50%.

In dollar terms, for Sarah's $10,000 investment:

• Fund A (Adjusted): $10,000 * 0.50% = $50
• Fund B: $10,000 * 0.50% = $50

In this hypothetical scenario, despite Fund A's higher stated gross expense ratio, its adjusted average expense for the current year matches Fund B's. This highlights why looking beyond the gross expense ratio to the adjusted figure is important for understanding the actual cost to the investor during the period. If the waiver for Fund A expires in subsequent years, its adjusted average expense would revert to 0.70% (or change based on new adjustments), making Fund B the cheaper option if its expenses remain at 0.50%.

Practical Applications

The adjusted average expense is a critical consideration in various aspects of personal finance and institutional investing. It is most frequently encountered when evaluating investment vehicles such as mutual funds and ETFs. Fund fact sheets and prospectuses will typically present both the gross expense ratio and the net expense ratio (which reflects the adjusted average expense after waivers or reimbursements)⁷.

Investors often use this figure to compare the true cost of different funds within the same category, aiding in the selection of more cost-efficient options. For example, a disciplined approach like passive investing, which often seeks to minimize costs, relies heavily on comparing these adjusted expense figures. Lower adjusted average expenses can significantly enhance an investor's total return over long periods due to the power of compounding. According to Morningstar's annual fund fee studies, investors have saved billions of dollars in fund expenses as asset-weighted average fees have continued to decline, driven by shifts towards lower-cost funds⁵, ⁶. This trend underscores the tangible benefits of considering adjusted average expense in investment decisions.

Limitations and Criticisms

While useful, the adjusted average expense has limitations. A primary criticism is that fee waivers and expense reimbursements, which lead to an adjusted average expense that is lower than the gross expense ratio, are often temporary⁴. Funds may implement these adjustments for a limited period to attract initial assets or improve short-term performance figures. Once these agreements expire, the fund's actual costs to investors may revert to the higher gross expense ratio. This can lead to unexpected increases in investment costs if investors do not monitor fee changes.

Additionally, while lower fees are generally associated with better performance, some academic research suggests that for certain actively managed funds, a higher fee structure might be correlated with specific investment strategies (e.g., those involving more research or complex valuation) rather than just being a drag on returns³. However, other studies generally find a strong negative association between net-of-fee fund performance and fees². Ultimately, solely focusing on the lowest adjusted average expense without considering the fund's investment strategy, management quality, or other operating expenses could lead to suboptimal investment choices.

Adjusted Average Expense vs. Expense Ratio

The distinction between adjusted average expense and expense ratio lies in the impact of fee waivers and expense reimbursements.

While the expense ratio provides the fundamental cost structure, the adjusted average expense offers a more immediate picture of what an investor is actually paying. Investors often become confused because the reported expense ratio in marketing materials might be the lower, "net" adjusted average expense, which could later increase if waivers are removed. Therefore, it is critical to understand both figures and the potential for cost changes.

FAQs

What does "adjusted" mean in adjusted average expense?

"Adjusted" means that the fund's stated annual operating expenses have been reduced by temporary fee waivers or expense reimbursements offered by the fund's advisor or management company. It reflects the lower, current cost to the investor.

Why do funds offer fee waivers or reimbursements?

Funds typically offer fee waivers or reimbursements to make their expense ratio more competitive, attract new investors, or help a fund reach a certain asset size. These adjustments can temporarily boost a fund's reported total return by reducing its costs.

How can I find a fund's adjusted average expense?

A fund's adjusted average expense, often labeled as the "net expense ratio" or "expense ratio after waivers," is typically disclosed in its prospectus, particularly in the standardized fee table. You can usually find this document on the fund company's website or through financial data providers.

Does a lower adjusted average expense always mean a better investment?

While a lower adjusted average expense is generally beneficial because it means more of your investment's returns are kept by you, it does not guarantee superior investment performance. Other factors, such as the fund's investment management strategy (e.g., active management vs. passive investing), portfolio turnover, and overall market conditions, also significantly impact returns. However, fees are one of the most reliable predictors of future net returns¹.