It is not a stunning revelation that fund investors prefer low cost exchange traded and mutual funds. New data from Morningstar suggest that investors’ preference for low-fee funds has an indelible impact on fund issuers’ decisions to lower costs.
“The asset-weighted expense ratio across all funds was 0.64% in 2014, down from 0.65% in 2013 and 0.76% five years ago,” according to the Morningstar study, Investors Are Driving Expense Ratios Down.
Not surprisingly, the lowest cost funds have been the most prolific asset gatherers.
“During the past decade, low-cost funds have been attracting far more inflows than their more-expensive peers,” said Morningstar analyst Michael Rawson in a note out Thursday. “Mutual funds and ETPs with expense ratios ranking in the least-expensive quintile of all funds attracted an aggregate $3.03 trillion of estimated net inflows during the past 10 years, compared with just $160 billion for funds in the remaining four quintiles. That is to say that 95% of all flows have gone into funds in the lowest-cost quintile.”
In the ETF space, low fees have played a pivotal role in the ascent of Vanguard and Charles Schwab (NYSE: SCHW), among others. Pennsylvania-based, which has knack for lowering fees on its ETFs as they accumulate more assets, has become the second-largest U.S. ETF issuer and has over $471 billion in ETF assets due in large part to its reputation as a low-cost leader. [More Fee Cuts from Vanguard]
“Vanguard had the largest increase in market share among the top 10 fund families over the past five years. The firm also has the lowest asset-weighted expense ratio among this group. Vanguard has widened its audience in recent years. In particular it has appealed to the growing field of fee-based financial advisors who might not have had an incentive to use Vanguard’s funds under a pay-for-distribution model,” according to Morningstar.
California-based Schwab was late entering the ETF business with its 2009 debut, but has overcome that tardiness by being a viable cost competitor to Vanguard. The most expensive Schwab ETFs cost just 0.32% per year and several charge investors just 0.04%, or $4 for every $10,000 invested. That compares with the ETF industry average equal-weighted expense ratio of 0.6% and the asset-weighted expense ratio of 0.3%. Schwab is now the seventh-largest U.S. ETF issuer with $32.2 billion in assets under management as of April 21. [Schwab Continues Torrid Pace of Asset Growth]
Even with the falling fees, fund issuers are not hurting because assets under management are surging.
“However, much of the increased economies of scale are going to the fund industry rather than investors. Assets under management have risen faster than fees have fallen,” according to Morningstar.
The global ETF industry is closing in on $3 trillion in assets under management, having finished the first quarter with $2.92 trillion in assets, according to ETF research firm ETFGI. U.S. ETF providers had a combined $2.09 trillion in assets at the end of the first quarter. [ETFGI: ETF Assets hit a Record in Q1]
Passive funds are driving fund industry growth.
“Passive funds focused on U.S. stocks have attracted $671 billion of inflows during the past 10 years, compared with outflows of $731 billion for active U.S. equity funds,” according to Rawson. “Passive funds now account for 28% of the total assets in the universe we’ve examined, up from 13% in 2004.”
Chart Courtesy: Morningstar