According to Morningstar, investors last year paid the lowest-ever average fees for mutual fund and ETF assets. “Fees in the asset management industry are coming under increasing scrutiny, and this trend has driven investment dollars into lower-cost funds, particularly index funds,” the research group said recently in a report.
The asset-weighted average net expense ratio of all U.S. funds in 2015 fell to 0.61% from 0.64% in 2014. While that drop may not seem very dramatic, consider the context: the asset-weighted average expense ratio for passive funds was 0.18% versus 0.78% for active funds.
Passive funds, in fact, took in $576 billion more in assets than active funds in 2015 despite the fact that there were eight times more active funds than passive ones. Meanwhile, investors and advisors have been favoring the least expensive funds, which over the past five years had inflows of $1.7 trillion while more expensive funds experienced outflows of $372 billion.
Funds that have lower expense ratios not only tend to outperform other funds within the same asset category, but they also tend to stay in business longer, according to Morningstar.
“High-cost funds are far more likely to get killed,” says Russel Kinnel, director of manager research at Morningstar.
The findings “worked for every category” over different time periods, Kinnel states. That includes international equity funds and sector equity funds where active management is often thought to yield better results, even though those funds have comparatively higher costs.
The divergence in performance among funds in different expense quintiles was sizable. For example, U.S. equity funds with the lowest expense ratios had a 62% success rate over the five years ended Dec. 31, 2015 — three times greater than the success rates of funds with the highest expense ratio.
Asked whether these study results are yet another argument in favor of passive index funds over actively managed funds, Kinnel says, “It’s about low cost, not active versus passive.” Passive funds may have the lowest costs, but not all passive index funds are less expensive than actively managed funds, says Kinnel.