A study on U.S. open-end mutual funds and exchange-traded funds, recently released by Morningstar, finds that, on average, investors paid lower fund expenses in 2015 than ever before. The asset-weighted average expense ratio across funds (excluding money market funds and funds of funds) was 0.61% in 2015, down from 0.64% in 2014 and 0.73% five years ago. This decline stems from investor demand for cheaper passive funds (index funds and ETFs) and strong flows into institutional share classes, which carry lower fees. Vanguard also contributed to average fee declines, as its low-cost passive funds continue to attract large flows.
But lower average fund expenses do not necessarily mean investors are paying less for their investments overall, reveals the study conducted by Patricia Oey and Christina West. 2015 saw the strongest inflows to institutional share classes through retirement platforms and to ETFs via fee-only advisors. These channels typically levy another layer of fees in addition to the cost of owning funds, so investors need to consider their total cost of investing. Advisor and retirement platform expenses are beyond the scope of this fund fee study, but they are an increasingly important cost component as investors migrate toward investment services and products with these fee structures.
The recently released U.S. Department of Labor’s final Fiduciary Rule states that any industry professional providing investment advice to IRAs and retirement plans (such as 401(k)s) must put the interest of the investor first, primarily by focusing on costs. This rule may result in more scrutiny and better transparency on the total cost of investing, which we hope will lead to lower investment expenses for the average American saving for retirement.
The asset-weighted average expense ratio is a better measure of the average cost borne by investors than a simple average (or equal-weighted average), which can be skewed by a few outliers, such as high-cost funds that have low asset levels. In 2015, the simple average expense ratio for all funds was 1.17%, but funds with an expense ratio above that level held just 8% of fund assets at the end of 2015. (So it isn’t saying much if a fund company touts “below average fees.”) If we look at the largest 1,000 share classes, which account for about 75% of assets in mutual funds and ETFs, the simple average expense ratio remained at 0.64% from 2013 through 2015, as some fees go up and some go down.
This finding suggests that in aggregate, changes in the fees set by asset management firms across the industry are not contributing to the falling asset-weighted average expense ratio.
Indeed, active funds have seen larger asset-weighted average fee declines when compared with passive funds. This might lead to the conclusion that fee declines among active funds are driving overall fee declines, but this has not been the case. Instead, it has been flows out of more-expensive funds (often active funds) and into cheaper funds (primarily passive funds) that have resulted in lower asset-weighted average fund fees.