The first quarter was not exactly stellar for mutual funds as Standard and Poor’s 500 lost 2.6%. This decline naturally most affected US stock funds that lost 2.5% on average, while international funds fared much better. MorningStar Inc. research shows that Foreign Small-Mid Growth funds had an average return of 3% in the first quarter of 2005. The returns of the funds holding foreign shares were boosted by the fall in the US dollar that increased the value of their holdings in dollar terms.

Natural-resources funds rode on surging oil prices scooping up a handsome 12.6% return, and bear-market funds that bet on a drop in equities, added 4.7%. Funds concentrated on utilities stocks pulled in a 2.8% gain.

The funds are now entering a maturing industry, as most investors with assets already own one or more funds. Increasingly, the borders between mutual funds with different pronounced investment strategies are blurred. Thus, a study by Merrill Lynch & Co discovered that the boundaries between income and growth funds are disappearing quickly as the two categories often hold the same stocks. The ten top favorites include Pfizer Inc., Microsoft Corp., Citigroup Inc., General Electric Co., Johnson & Johnson, Tyco International Ltd., American International Group Inc., International Business Machines Corp., J.P. Morgan Chase & Co. and Exxon Mobil Corp, often found in portfolios of both income and growth funds. Even with some overlap, managers of the funds labelled as «growth» tend to favor financial stocks usually avoided by their colleagues in income firms, and invest in auto manufacturers, retailers and media companies. Value funds, on the contrary, prefer grocery stores and food and tobacco companies. In the past few years, value funds were able to outperform their growth counterparts, and now analysts predict growth investing is in for a comeback.

The mutual fund industry has yet to cope with tougher regulatory oversight, as starting this year the SEC rules about greater disclosure of fund fees take effect. The new rules require more detailed disclosure of the fee structure that was previously outlined in the Statement of Additional Information, rarely accessed by fund investors. The SEC is going further, probing into "the extent to which economies of scale would be realized as the [fund] grows; and whether fee levels reflect these economies of scale for the benefit of the [fund’s] investors."

Oddly enough, the new disclosure requirements that are going to raise costs for funds, are at the same time likely to cause a drop in fund fees, one of the basic factors that eat away at the fund’s performance. More detailed disclosure will create extra incentives to lower their fees, especially as they accumulate assets, so as to pass their economies of scale to the consumers. These economies are generated in the first place by the so-called breakpoints, provisions in the contract with the people actually managing the assets that stipulate a decrease in fee per asset amount if the assets under management reach a certain threshold. Thus, a fund with a greater amount of assets will be able to recruit its manager for a cheaper per-unit pay. Advisory fee typically comprises the largest single expense of a mutual fund and goes to the manager for the efforts in choosing the fund assets.

This year 90 fund companies have already cut their fees at 844 funds. The cuts are also inspired by the regulatory probes by New York Attorney General Eliot Spitzer. The settlement of the probes involved a promise by a number of funds to lower their fees by $925 million in the next few years.

The most famous cuts included Fidelity Investments’ decision to lower fees on index funds, and a reduction in advisory fees at American Funds. These funds and the Vanguard Group were among the few that successfully weathered a scandal in the industry, and continue to attract shareholders with their low costs and customer-friendly policies. The industry as a whole is getting more and more competitive, which in turn forces funds to cut fees further. Index funds in particularly were pressed by sharpening competition from exchange-traded funds (ETFs) that have the advantage of trading on the exchange like a stock.