The latest analysis published by the Investment Company Institute (ICI) highlights a trend of falling expense ratios for long-term mutual funds that has now continued for more than 20 years.
In 1996, ICI reports, equity mutual fund expense ratios averaged 1.04%, but this figure fell to 0.59% by the end of 2017. Hybrid mutual fund expense ratios averaged 0.95% in 1996, and these also fell substantially over the time period, reaching 0.70% in 2017. On the fixed-income side, bond mutual fund expense ratios averaged 0.84% in 1996, compared with 0.48% in 2017.
As ICI explains, 2017 saw only a relatively modest drop in prices, and it remains to be seen whether mutual fund prices have reached a floor. In particular, in 2017, average expense ratios for equity mutual funds fell four basis points to 0.59%, ICI reports. Average hybrid and bond mutual fund expense ratios declined just three basis points from their values in 2016, to 0.70% and 0.48%, respectively. Interestingly, the average expense ratios for money market funds rose five basis points in 2017 to 0.25%.
“This increase was indirectly related to the Federal Reserve raising short-term interest rates three times in 2017,” ICI reports. “These actions prompted fund advisers to continue paring expense waivers that most money market funds offered during the period of near-zero short-term interest rates that had prevailed in the post-financial crisis era.”
Expense ratios of target-date mutual funds averaged 0.44% in 2017. Since 2008, ICI explains, the expense ratios of target-date mutual funds have fallen 34%.
“Because these funds are attractive to individuals saving for retirement, investor demand for them have flourished in recent years,” ICI says. “Ninety-five percent of target date mutual funds are funds of funds—mutual funds that invest in other funds—the expense ratios of which fell from 0.65% in 2016 to 0.58% in 2017.”
Other high-level trends reported in the ICI data show average expense ratios for both actively managed and index equity mutual funds have fallen since 1996. In 2017, the average expense ratio of actively managed equity mutual funds fell to 0.78%, down from 1.08% in 1996, ICI says. On the other hand, index equity mutual fund expense ratios fell from 0.27% in 1996 to 0.09% in 2017.
“Investor interest in lower-cost equity mutual funds, both actively managed and indexed, has fueled this trend, as has asset growth and resulting economies of scale,” ICI highlights. “Economies of scale and intense competition are putting downward pressure on expense ratios of exchange-traded funds (ETFs). In 2017, the expense ratios of index equity ETFs fell to 0.21% (down from 0.34% in 2009). Expense ratios of index bond ETFs, down from a recent peak of 0.26% in 2013, fell to 0.18% in 2017.”
According to the ICI analysis, inflows to actively managed and index funds continued to be concentrated in relatively low-cost funds. Actively managed domestic equity funds with expense ratios among the lowest 5% saw inflows, while actively managed world equity and actively managed bond and hybrid funds with expense ratios in the lowest quartile received inflows.
“Index funds experienced inflows in every quartile of expense ratios and for each investment category, but like actively managed funds, these inflows were concentrated in funds with the lowest costs,” ICI explains.
Another trend of note to the retirement audience, concerned as it is with regulatory change around the fiduciary standard and adviser conflicts of interest, is that no-load mutual fund share classes continue to experience positive net new cash flow. In 2017, no-load mutual fund share classes received net inflows of $447 billion, ICI reports, while load mutual fund share classes experienced net outflows of $296 billion.
“This disparity, in large part, reflects a growing trend—investors paying intermediaries for advice and assistance directly out of their pockets rather than indirectly through funds,” ICI notes.
As the report lays out, many mutual fund investors pay for the services of a financial advice professional within their mutual fund expense ratios—but this practice is shifting.
“These professionals typically devote time and attention to prospective investors before investors make an initial purchase of funds and other securities. Usually, the professional meets with the investor, identifies goals, analyzes the investor’s existing portfolio, determines an appropriate asset allocation, and recommends funds to help achieve the investor’s goals. Financial professionals also may provide ongoing services, such as periodically reviewing investors’ portfolios, adjusting asset allocations, and responding to customer inquiries,” ICI explains.
Traditionally, fund shareholders usually compensated financial professionals through a front-end load fee—a onetime, up-front payment for current and future services.
“Over the last 30 to 40 years, the way in which investors compensate financial professionals, also described as ‘distribution structures,’ has increasingly shifted towards the use of asset-based fees,” ICI notes. “Asset-based fees are assessed as a percentage of the assets that a financial professional manages for an investor, rather than as a percentage of the dollars initially invested. Investors may pay these fees indirectly through a fund’s 12b-1 fee, which is included in the fund’s expense ratio. The fund’s underwriter collects the 12b-1 fee, passing the bulk of it to financial professionals. Alternatively, investors may pay the professional an asset-based fee directly. In such cases, the financial professional typically would recommend the purchase of some mix of ETFs and no-load mutual funds (no-load mutual funds have neither a front-end load fee, nor a back-end load fee, nor a 12b-1 fee of more than 0.25 percent).”
In part because of the trend toward asset-based fees, ICI finds the total net assets of load share classes have fallen as a percentage of all long-term mutual fund total net assets, while the total net assets of no-load share classes have increased substantially. For example, the total net assets of load share classes have fallen from 42% of long-term mutual fund total net assets at year-end 2000 to just 15% at year-end 2017, ICI says. Beginning in 2010, load share classes have seen net outflows of more than $1.0 trillion, and gross sales of back-end load share classes have dwindled almost to zero.
“By contrast, no-load share classes have seen net inflows and rising assets since the beginning of 2000,” ICI concludes. “No-load share classes have accumulated the bulk of the net inflows to long-term mutual funds during this time and have experienced net inflows of nearly $2.0 trillion from 2010 alone. At year-end 2000, no-load share classes accounted for 43% of long-term mutual fund total net assets, rising to 70% by year-end 2017.”
The full report is available for download here.
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