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From Morningstar: 

Gregg Wolper
On Tuesday May 5, 2009, 7:00 am EDT

The stock market’s up. Some earnings reports aren’t as horrible as feared. Politicians looking at the economy see signs of hope.

Well, good. But for most people, times remain tough. Many have lost jobs, know people who have, or fear the ax might still fall. Even those still working have had wages frozen and benefits cut.

Yet the monthly bills keep pouring in. In response to this squeeze, many of you are cutting back on costs wherever possible, news reports say. Fast-food or casual dining instead of fancy restaurants–or maybe just a plate of spaghetti at home. Bringing lunch to work is back in style. The store brand at your local grocery suddenly seems worth a shot.

In this climate, it may seem odd that so many mutual funds expect you to pay a lot more for their services.

In a sense, that trend is not as strange as it appears. Most fund advisors aren’t actively boosting their fees. In general, it’s just mathematics: Funds have a certain amount of fixed costs, and when assets decline as sharply as they have in the bear market, the percentage of fund assets devoted to expenses–the expense ratio–can rise substantially even if the fund’s advisory fee hasn’t budged and the fund hasn’t spent any more on printing or legal bills. This effect was heightened in cases where the advisory fee did rise (in percentage terms) because declining asset levels fell through automatic breakpoints that had trimmed those percentages as assets grew.

However, these explanations only go so far. Mathematics might explain rising expense ratios, but that doesn’t mean you must accept them. After all, there’s no law saying that a fund’s expense ratio must rise. Funds can waive a portion of the management fee–that often happens with new offerings–or can otherwise cut costs to keep that ratio from climbing (that is, not all of a fund’s costs are completely “fixed”).

There’s no rule stopping you from switching to a cheaper fund if a once-reasonable charge has become less tolerable. At a time when many of you are slashing your grocery bill and telling your kids to reconsider their college choices, why simply accept higher costs from your funds?

You might prefer not to sell completely, owing to tax concerns or other reasons. But at the very least, take a look at the expense ratio on the “financial highlights” page when your annual and semiannual reports arrive in the mail. (You can also find these documents by going to the fund’s page on Morningstar.com and clicking on SEC Filings in the menu bar at left.) If that expense ratio rose more than a tad, call up the fund and tell them that you don’t appreciate it. Or, as Morningstar’s Russel Kinnel suggested in the column cited above, contact the fund’s board of directors. If a great many of you let funds know that they can’t count on passive acceptance of higher costs, it could pay off down the road even if it doesn’t bring immediate results.

(Note that the expense ratio in these reports refers to the past year or half-year in question. For a more up-to-date figure, see the fund’s latest prospectus, if one has been issued recently.)

Some good funds understand the concept. Take Sound Shore (NASDAQ:SSHFX - News). Advised by the unassuming but excellent Sound Shore Management, its assets dropped from $2.7 billion at the end of 2007 to $1.6 billion a year later. But its expense ratio for both years was 0.92%. Granted, the expense ratio isn’t based on the year-end asset figure; it’s calculated on an ongoing basis, and the sharpest decline in assets didn’t strike until late in 2008. So shareholders will get socked with a huge increase this year, right? Don’t count on it. In its new prospectus released just last week, Sound Shore estimated that its 2009 expense ratio will rise a mere 2 basis points–to 0.94%.

Then there’s UMB Scout Stock (NASDAQ:UMBSX - News), a solid fund that shares a manager with the highly esteemed UMB Scout International (NASDAQ:UMBWX - News). It’s also a sibling to one of the funds highlighted in a recent Fund Spy column about tiny funds that deserve more attention. UMB Scout Stock has never been a big fund itself, and its asset base fell 22% between mid-2006 and mid-2008. (It uses a June fiscal year.) But the fund’s expense ratio stayed at 0.90%–a very reasonable cost for a fund with only about $100 million in assets–because the advisor waived some fees to keep that ratio from rising. Moreover, the advisor’s chairman told Morningstar last week that the 0.90% cap is likely to stay in place indefinitely.

Of course, you shouldn’t sell a high-quality fund just because its expense ratio rose in a very unusual 2008, especially if the cost is still at a reasonable level. (Many Vanguard index funds have seen their expense ratios rise, but I certainly wouldn’t sell any of them for that reason. Or even complain.) What’s critical is to keep an eye on what your fund is charging you. Voice your displeasure if you don’t like what you see, or take your business elsewhere if that works for your situation. With the economy in recession and personal finances precarious, there’s no reason that mutual fund costs should get a pass.

Gregg Wolper has a position in the following securities mentioned above: SSHFX

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