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Fund Flows Fan Falling Fund Fees

A new study of U.S. open-end mutual funds and exchange-traded funds finds that on average, investors paid lower fund expenses in 2016… than ever before.

The Morningstar study found that the asset-weighted average expense ratio across funds (excluding money market funds and funds of funds) was 0.57% in 2016, down from 0.61% in 2015 and 0.65% three years ago.

The report attributes this to strong investor demand for lower-cost funds, principally passive funds and institutional share classes that carry lower fees.

The study found that the simple average expense ratio of the largest 2,000 funds (in 2013), which accounted for 85% of assets in mutual funds and ETFs, was 0.72% in 2016, unchanged from 2015 and 2014. On average, then, the fund industry is not cutting fees on the most widely held funds – and, according to the report, that means the decline in average mutual fund fees paid by investors stems largely from investors’ migration to lower-costs funds.

In fact, the report notes that active funds saw a cumulative negative $586 billion in net flows in 2015 and 2016 – an exodus from expensive funds, defined as those with fees that rank among the bottom 80%. These “pricey” funds saw $627 billion in outflows; low-priced active funds (funds with fees that rank among the cheapest 20%), saw small but positive $41 billion of flows over that two-year period.

Not surprisingly, U.S. equity funds have seen the largest migration to passive funds from active funds, with the former drawing in $458 billion of inflows and the latter experiencing $524 billion of outflows over the past three years. During the same time period, U.S. equity funds’ asset-weighted average fees fell a cumulative 17% to 0.50%, the largest decline of any asset class, according to the report.

Morningstar notes that Vanguard has had a significant impact on the industry’s asset-weighted average expense ratio and the recent pace of fee declines, as the company’s low-cost passive funds continue to attract large inflows. From 2013 to 2016, the industry-wide asset-weighted average expense ratio fell to 0.57% from 0.65%, a decline of 14%, or 8 basis points. Excluding Vanguard, however, the industry’s asset-weighted average expense ratio in 2016 would have been higher, at 0.69%, and would have exhibited a smaller decline – 9%, or 7 basis points.

Indeed, Vanguard boasts the lowest asset-weighted average expense ratio of 0.11%, followed by SPDR State Street Global Advisors (0.19%) and Dimensional Fund Advisors (0.36%). During the past three years, Vanguard’s asset-weighted average fee declined a cumulative 21%, the biggest drop among the largest 10 fund families, followed closely by BlackRock/iShares, according to the report.