Big Shift to Passives, Institutional Shares Drives Average Fund Costs Lower

By ASPPA Net Staff • April 28, 2016 • 0 Comments
Average fund costs continued to decline in 2015, but investors aren’t necessarily paying less, according to Morningstar.

The study of U.S. open-end mutual funds and exchange-traded funds finds that 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.

The report notes that the 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.
That said, the report cautions that lower average fund expenses do not necessarily mean investors are paying less for their investments overall.

Morningstar notes that the strongest inflows are going 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,” according to the report.

Passives ‘Active’

Specifically, the report notes that the cheapest funds (the funds with net expense ratios in the lowest quintile) have drawn $1.7 trillion in flows, while more expensive funds (those with net expense ratios in the remaining quintiles) have seen outflows of $372 billion during the past five years. During that time, passive funds (index funds and ETFs), on average, have accounted for about 75% of flows into the cheapest funds, with active funds accounting for the remaining 25%.

For passive funds, the asset-weighted average expense ratio was 0.18% in 2015, compared with 0.78% for active funds. In 2011, passive funds gathered $140 billion more than active funds, but in 2015, this gap widened to $576 billion — despite the fact that, according to Morningstar, there are eight active funds for every passive fund.

The trend toward passive funds has become more dramatic as the difference in flows between active funds and passive funds grows ever larger. From 2011 through 2014, estimated net flows into passive funds hit $1 trillion, with net flows into active funds coming in at about a fourth of that amount, at $237 billion. In 2015, active funds saw a large net outflow, resulting in a net flow difference of $575 billion between active funds and passive funds. Indeed, since 1990, active funds have seen outflows only once before — in 2008. Passive funds now account for 29% of the total assets in the universe examined by Morningstar, up from 14% in 2005.

As for Vanguard’s influence, the report notes that during the past five years, the industry-wide asset-weighted average expense ratio experienced a decline of 12 basis points, falling from 0.73% to 0.61%. That said, excluding Vanguard, the industry’s asset-weighted expense ratio declined 5 BPs over the same period, dropping from 0.82% to 0.77%. Additionally, in the past five years, the asset-weighted average expense ratio of Vanguard’s funds fell from 0.18% to 0.12%, the largest percentage decline among the 10 largest fund providers.

The report also notes that the Labor Department’s recently released fiduciary regulation may result in more scrutiny and better transparency on the total cost of investing.