Mutual fund and ETF investors apparently deserve much of the credit for the falling average expense ratio, as the shift toward low-cost funds has been the primary driver of this decline, according to Morningstar’s annual fund fee study.
The study, which evaluates trends in the cost of U.S. open-end mutual funds and exchange-traded funds (ETFs), found that the average expense ratio paid by fund investors is half of what it was two decades ago. Between 2000 and 2020, the asset-weighted average fee fell from 0.93% to 0.41%.
From 2019 to 2020, the asset-weighted average expense ratio fell from 0.44% to 0.41%. As a result, the Morningstar researchers estimate investors saved nearly $6.2 billion in fund expenses last year.
And a few billion saved means more dollars earned in the years to come, according to the report. “Compounding investors’ 2020 fund fee savings at a rate of 0.71% over the next 10 years would equate to $6.6 billion more in investors’ pockets come 2031,” writes Ben Johnson, Morningstar’s director of ETF and passive strategies research, and author of the report.
The asset-weighted average expense ratio for active funds dropped from 0.65% in 2019 to 0.62% in 2020, driven by large net outflows from expensive funds and share classes and, to a lesser extent, inflows to cheaper ones. The asset-weighted average expense ratio for passive funds fell from 0.13% in 2019 to 0.12% in 2020, due to steady flows into the lowest-cost funds.
Much of the decline documented in the asset-weighted fees paid by investors can be attributed to the fact that they’ve been allocating more of their investment dollars to low-cost index mutual funds and ETFs and that those same funds have been slashing their expense ratios, the report notes.
Intensifying competition among asset managers has also resulted in many cutting fees to vie for market share. The move toward fee-based models of charging for financial advice has been a key driver of the shift toward lower-cost funds, share classes and fund types—most notably exchange-traded funds, the report explains.
“The fact that fees have been reduced to either nothing or next to nothing among broad-based index funds is only natural,” says Johnson. “Given these funds’ commodity-like nature, it seems inevitable that their prices would be pushed down to the marginal cost of managing them and that assets would consolidate in the hands of a few large-scale manufacturers.”
According to Morningstar, low-cost funds generally have greater odds of surviving and outperforming their more expensive peers. In 2020, the cheapest 20% of funds saw net inflows of $445 billion, with the remainder experiencing outflows of $293 billion. The cheapest 5% of funds alone received $412 billion of inflows.
Moreover, in 9 of the last 10 years, the cheapest 20% of funds across all Morningstar Categories have, as a group, accounted for 100% of the net inflows into all funds. In the meantime, money has switched out of the remaining 80% in all but one year over the past decade. “The sums are staggering,” says Johnson, who notes that more than $5 trillion has flowed into the low-cost cohort during this 10-year span, while nearly $1.9 trillion has been pulled from the remaining funds.
In the advice space, bundled share classes have been in outflows for the past 11 years while semi-bundled and unbundled share classes have seen steady inflows, the report notes. Additionally, the shift away from transaction-driven business models and toward fee-based ones has led advisors to recommend lower-cost funds to their clients, the report further suggests.
As a result, Morningstar notes, bundled funds and share classes have been a casualty of the move toward fee-based advice. These funds and share classes accounted for 43% of fund assets in 2000, but by the end of 2020, their share had declined to 16%.
And in the retirement space, TDFs have experienced significant growth as the default investment option in many retirement plans. The majority of TDF assets are now in target-date series composed exclusively of index mutual funds. “Taken together, these three factors help explain the sea change we have witnessed from active funds to passive ones, costly ones to inexpensive ones,” writes Johnson.
Though fund costs have come down, Morningstar notes that the total costs borne by investors have not necessarily followed in lockstep, as some costs have diminished, but others have taken new shape, such as the move toward fee-based advice.
Sustainable Funds’ ‘Greenium’
Meanwhile, investors in sustainable funds are paying what Morningstar dubs a “greenium” relative to investors in conventional funds. This, according to the report, is evidenced by these funds’ higher asset-weighted expense ratio, which stood at 0.61% at the end of 2020 versus 0.41% for their traditional peers. The report adds, however, that this fee has been shrinking.
Sustainable funds’ equal-weighted average fee has fallen 27%, while the asset-weighted average fee paid by investors in these funds has dropped 38% over the past decade. This has been driven in large part by the introduction of low-fee sustainable index mutual funds and ETFs to the menu, many of which have gained favor with investors, the report notes.