How Does the Domiciliation Decision Affect Mutual Fund Fees?

In this paper, we analyze if the integration of the European mutual funds industry has brought advantages to private and institutional investors. Moreover, we examine the possible determinants of fund fees as well as the effects of domiciliation decisions of fund companies. Investors worldwide invest in more than 65,000 different investment funds, since these are perceived to be liquid and diversified assets with lower cost than direct investments. The fees investors are generally charged include fees for the fund’s set-up, portfolio management, custody of the shares, marketing and sales etc. In theory, higher fees result in a lower investment performance. Yet it has been shown that there exists no correlation between higher fund fees and good fund performance. For the fund company, however, higher fees translate directly into higher profits, i.e. there is a conflict of interest between the market participants. As a result of legal and regulatory harmonization in the European financial industry, competition between fund companies has risen greatly over the past few years. In order to benefit from economies of scale, fund companies have concentrated their activities in a single location. This has also led to increased competition between countries seeking to attract these financial institutions. In this respect, Luxembourg and Ireland play a particular global role as specialized financial centers. However, the question arises whether investors really benefit from this market concentration beyond the greater number of investment opportunities. The results show that the fees charged by funds differ significantly across countries and across fund types. It is also shown that funds domiciled in Luxembourg have considerably lower cross-border distribution costs. This advantage is, however, countered by several drawbacks. Generally, funds complying with UCITS policy are most expensive for investors. Furthermore, fees rise with an increase in the number of countries in which the fund is distributed, as additional distribution partners and permits are required. The results do not clearly show that investors pay lower fees for funds from Luxembourg or Ireland than for funds of other countries. All in all, it is shown that the market integration of the European fund industry has reduced costs significantly, due mainly to the concentration of specialists in clusters and economies of scale, leading to greater welfare. The implementation of the UCITS IV Directive has increased the need for a more thorough examination of the supply side of the fund industry.

Lang, Gunnar and Matthias Köhler (2011), How Does the Domiciliation Decision Affect Mutual Fund Fees?, ZEW Discussion Paper No. 11-085, Mannheim.