Morningstar’s latest annual report on fund fees offers multiple reasons why advisors and investors should favor lower cost funds.
Not only do they tend to perform better than higher cost funds within the same asset category, they are more likely to experience bigger inflows and smaller outflows than higher cost funds.
In addition, lower fee funds allow more room for advisors’ own fees if they charge clients based on a percentage of their assets, writes Ben Johnson, director of global exchange-traded fund research for Morningstar, in a blog post accompanying the report.
Morningstar reports that over the last six years, the cheapest 20% of funds across all Morningstar categories experienced positive net flows, while the remaining 80% experienced net outflows.
‘The sums are staggering,” Johnson writes. “Nearly $3.6 trillion has flowed into the low cost cohort during this six-year span, while $1.6 trillion has been pulled from the remaining funds.”
In 2019 alone, $581 billion flowed into the cheapest 20% of funds on a net basis while $224 billion left the remaining, more expensive funds.
Fund fees have been falling for years. Between 1999 and 2019, the average asset-weighted fund fee, which reflects what investors paid for the funds they invest in, fell from 0.87% to 0.45%. In 2018, the average asset-weighted fund fee was 0.48%.
That 3 basis-point decline translates into $5.8 billion in savings for fund investors, says Johnson. Compounded at a 4.93% annual rate, that equates to $9.4 billion more in investors’ pockets by 2030, he writes.
In 2019, the asset-weighted average expense ratio for active funds fell from 0.68% to 0.66%, representing a 3% decline. For passive funds, it fell from 0.14% to 0.13%, equivalent to an 8% drop.
Another way to look at fund fee changes is to study what asset managers charge, rather than what investors purchase. The former is represented by what Morningstar calls the equal-weighted average fee.
From 2018 to 2019, the equal-weighted average expense ratio for funds fell from 1.03% in 2018 to 1.01% in 2019, but it only fell for active funds. Those funds saw a drop in the equal-weighted average fee from $1.11 to $1.08, while passive funds saw an increase in the equal-weighted average fee, from 0.60% to 0.61%.
Nearly 21% of passive funds reported higher fees in 2019 compared wi 9% previously, largely because declining asset levels left them below fee breakpoints.
Johnson credits individual investors “for putting the squeeze on fees … The fact that asset-weighted fees have dropped more sharply than equal-weighted fees indicates that investors, on average, chose funds with below-average fees.”
They continue to choose Vanguard over others. The fund giant had the lowest asset-weighted average expense ratio among asset managers in 2019: 0.09%, but some competitors have either matched or undercut its fees for certain passive market-cap weighted index funds, according to Morningstar.
State Street Global Advisors and BlackRock/iShares followed Vanguard for the lowest asset-weighted average fees, charging 0.16% and 0.27%, respectively.
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