The average cost of US managed funds has plummeted by almost half over the last 20 years driven by the shift to indexing, rising assets under management and pressure from fee-conscious investors, new research reveals.
According to the Investment Company Institute (ICI) study, the average total expense ratio (TER) for equity funds in the US fell from almost 1 per cent in 1997 to 0.55 per cent by the end of 2018. During the same period, the average bond fund TER dropped from 0.82 per cent to 0.48 per cent.
Last year average equity fund fees in the US fell a further 0.04 per cent – the ninth consecutive yearly price drop in the sector.
And it wasn’t just index funds forcing the overall costs lower, the ICI says.
“In 2018, the average expense ratio of actively managed equity mutual funds fell to 0.76 percent, down from 1.04 percent in 1997,” the report says. “Index equity mutual fund expense ratios fell from 0.27 percent in 1997 to 0.08 percent in 2018.”
The two-decade decline in US fund TERs was temporarily disrupted over 2008-2009 when assets under management slumped during the global financial crisis. However, since 2009 steadily-increasing asset pools pushed fund TERs lower as economies of scale kicked in.
US investor preference for lower-cost options among both active and index funds has intensified the scale advantage at the cheap end of town, the report says.
“Investor demand for index mutual funds is disproportionately concentrated in funds with the lowest costs,” the ICI study says. “In 2018, for example, 80 percent of index equity mutual fund total net assets were in funds with expense ratios that were among the lowest 25 percent of all index equity mutual funds.”
The economies of scale available to the on-average larger index fund sector also partly explains why passive options tend to be cheaper than actively-managed products.
“In 2018, the size of the average index equity mutual fund ($6.3 billion) was more than four times as large as the size of the average actively managed equity mutual fund ($1.5 billion),” the ICI paper says.
However, the report – authored by James Duvall, ICI associate economist – notes that index funds are intrinsically cheaper to run than their active counterparts due to lower turnover. Passive equity funds also tend to clump around the more liquid large stocks compared to active funds – which again keeps a lid on costs. Furthermore, more actively-managed funds bundle advice fees into the TER than index providers, which pushed the average fee gap between the two styles even wider.
Within the index universe, the ICI study found exchange-traded funds (ETFs) were more than twice as expensive as unlisted passive products: the average equity ETF cost 0.20 per cent compared to just 0.08 per cent for unlisted versions.
The study says the difference between ETF and unlisted fund TERs is partly due to the larger average size of the latter.
“In 2018, the average fund size for long-term index mutual funds was $7.1 billion, more than three times the average fund size of index ETFs ($2.2 billion),” the report says.
Nonetheless, the US ETF industry has grown significantly since 2005 from representing just 3.3 per cent of the total fund market to 15.7 per cent last year.
“Index ETFs accounted for half of the 31.4 percent of the market share [occupied by] index mutual funds and index ETFs in 2018,” the ICI paper says.
“… Beginning in 2009, competition and economies of scale within the ETF industry appear to have put downward pressure on equity ETF expense ratios. The number of equity ETFs more than quadrupled from 2004 to 2009, and then more than doubled again over the next nine years. By the end of 2018, 1,510 equity ETFs competed for investors’ business.”
ICI represents the interests of, mainly US-based regulated, fund firms from its offices in Washington DC, Hong Kong and London. In total, members of the industry organisation manage about US21.9 trillion and a further US$6.6 trillion in other jurisdictions.