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Fund Fees Plunge Thanks to Investors

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Fund expenses are coming down, but don’t thank the financial services industry—pat yourself on the back. The fees are dropping, a new report says, because more investors are choosing low-cost funds, not because an industry with assets at an all-time high is passing along the benefits of its huge economies of scale.

A fee study by Morningstar Inc. shows how investors have overwhelmingly favored low-cost index funds and exchange-traded funds over the past five years—index funds, for the most part, but low-cost actively managed funds, too. All but 5% of the money going into funds went to products with expenses in the lowest 20% of the fund universe. And where investors are benefiting from economies of scale, it’s largely because a long bull market has swelled some accounts to a dollar amount at which they automatically qualify for a break on fees.

The study doesn’t give a straight, equal-weighted average for expense ratios. (Expense ratios show the percentage of fund assets deducted annually to cover fund expenses.) If it did, the universe of many small mutual funds with higher expense ratios would skew the results. If you do use a straight average, you get 1.19% as the average for all funds in 2014, the study says. But 91% of industry assets are in funds with expense ratios lower than that. So Morningstar used an asset- weighted expense ratio, and that shows a drop from 0.76% in 2009 to 0.64% in 2014.

While that’s good, expense ratios should and will continue to shrink, predicts Michael Rawson, the study’s co-author. That’s partly because investors are voting with their feet. While funds deserve to make a profit, a fund’s costs don’t tend to rise that much as its assets swell, so the fund companies can afford to share more of the wealth, he figures. Industry fee revenue has grown by about 78% over the past 10 years, to $88 billion in 2014, while industry assets rose 143%, according to the study. Meanwhile, the asset-weighted expense ratio across all fund categories fell 27%.

A spokesman for the Investment Company Institute, the industry trade group, declined to comment on the study, but wrote in an e-mail that the group’s data show that from 2000 to 2013 industry competition and investors focusing on lower costs led to a cumulative drop in average mutual fund expense ratios paid by investors of 25% for equity funds and almost 20% for bond funds.  The big picture in the fund world, of ”a relentless shift to low-cost funds and passive management,” is a good one, says Mercer Bullard, a securities law professor at the University of Mississippi School of Law. (Bullard is a shareholder advocate who has been an expert witness for the plaintiffs in lawsuits about excessive fees.) But there are still a lot of funds for which shareholders are paying too much, he says.  

The Morningstar category of alternative mutual funds, or funds which use a variety of hedge-fund-like strategies, may fit that bill. Asset-weighted expense ratios for these funds rose to 1.31% from 1.24% over the past five years. That’s more than double the 0.64% asset-weighted expense ratio for all funds. The goods news, if you think that expense ratio is excessive: The funds have just 1.4% of total industry assets.

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