The Benefits of Brokers: A Preliminary Analysis of the Mutual Fund Industry

Mutual fund investors not only voluntarily engage professional investment managers, but also many willingly engage and pay professional brokers or advisors. Compared with direct distribution, brokered distribution is labor-intensive and consequently more costly to consumers. Presumably, consumers must perceive that they receive incremental benefits from using a broker. In this paper, we analyze four possible benefits that consumers of brokered fund distribution might enjoy: (a) Assistance selecting funds that are harder to find or harder to evaluate; (b) Access to funds with lower costs excluding distribution costs; (c) Access to higher performing funds; and (d) Attenuation of behavioral investor biases. Along these dimensions, it is difficult to identify the tangible benefits delivered by brokers. While brokerage customers are directed toward funds that are harder to find and evaluate, they pay substantially higher fees and the funds they buy underperform compared to directly-placed funds. Furthermore, brokered clients demonstrate more performance sensitivity, responding much more strongly to very short term performance. While there may be benefits of being a brokerage customer, they are not easily captured by these tangible measures. Daniel Bergstresser Harvard Business School Soldiers Field Boston, MA 02163 John Chalmers University of Oregon Lundquist College of Business Eugene, OR 97403 Peter Tufano Harvard Business School and NBER Soldiers Field Boston, MA 02163 dbegstresseserc2i~hbs.edu jchalmer~uoregon.edu [email protected] * We have received very valuable preliminary comments and education from Kasturi Rangan (HBS), Jon Reuter, seminar participants at the University of Arizona, and from staff members of the Investment Company Institute and National Quality Research, along with representatives of various fund companies. We thank Financial Research Corporation and Morningstar for sharing data with us. The comments in this paper do not reflect the views of any of these organizations. We thank the Harvard Business School Division of Research, MIT and theUniversity of Oregon for providing funding for this project.