Setting aside where major asset classes may go in the coming months or years, it is clear that there has never been a better time to be an investor in basically any market.
For years there has been a major, industry-upending trend on Wall Street, where the prime beneficiaries are individual investors, and not the old-school investment shops who offered market exposure for fees that by today’s standards seem astronomical. The main driver of this revolution: the move to low-fee products, and the fees that are falling to keep these cost-conscious investors.
Much of this shift can be connected to the rise of passive investing, or funds that track indexes like the S&P 500
by holding the same components as the underlying index, and in the same proportion. This is in contrast to actively managed funds, where the holdings were selected at the discretion of a portfolio manager. The additional costs of running active funds meant higher fees, which erode returns over time. In addition, data have repeatedly shown that few actively managed funds are able to do better than their underlying index over long periods, meaning many investors were essentially paying more for worse results.
Fueled by these factors, passive funds have seen massive adoption at the expense of active ones. According to Morningstar Direct, actively managed U.S. equity funds have seen outflows of $202.3 billion over the past year (including both mutual funds and exchange-traded funds). Passive ones have seen inflows of $236.1 billion.
While performance is part of this equation, fees seem to be a particular focus for investors. According to Vanguard, which cited May data from Morningstar, there is nearly $8 trillion in funds that charge between 1 and 47 basis points (or 0.01% and 0.47% of assets). The next cheapest category—charging between 0.48% and 0.65% of assets—has about $2.5 trillion, a downward slope that continues the more expensive the fund is.
In a move to staunch this bleeding of assets (and thus, revenue), active managers have become more aggressive in cutting fees. In 2017, more than 650 actively managed U.S. stock funds cut their fees, or about 37% of all the 1,750 funds that Morningstar tracks in this category. In 2016, only 469 funds cut their expense ratios.
“Active U.S. equity funds are slowly getting the message on fees,” wrote Kevin McDevitt, senior research analyst at Morningstar. However, he noted that the average fee cut was 6 basis points, which amounts to savings of $6 for every $10,000 investing, a degree of change he called “underwhelming.” (The median fee cut was a reduction of 3 basis points.)
“It’s good to see active U.S. equity funds becoming more proactive in cutting their expense ratios. Nevertheless, unless competitive or market pressure increases, cuts are likely to remain modest and incremental,” McDevitt wrote.
That 0.06% reduction is merely the latest in a massive and multiyear fee erosion. According to the Investment Company Institute, expense ratios for U.S. equity ETFs dropped by nearly a third between 2009 and 2016, falling 32% to an average of 23 basis points from 34 basis points. Equity mutual fund fees fell to 0.63% from 1.04% over the same period. (ETFs are dominated by passive strategies while mutual funds have a higher concentration of active funds, although passive and active strategies are available in both structures.)
This has occurred in funds for basically all investing styles and asset classes, from stocks to bonds to gold. Many of the most popular stock funds now charge less than 0.05%, and in what is perhaps the natural endpoint of this, Fidelity is offering a Flex International Index Fund
which tracks overseas stocks. According to a filing that was revised on Wednesday, the fund will charge an annual operating expense of 0.00%, making it free to own, although it is only available to certain fee-based Fidelity accounts. (The fund will earn income by lending securities out to broker-dealers and other institutions.)
While funds with 0% expenses may not become the norm, fees have gotten so low that Vanguard—a major fund sponsor that makes low fees one of its dominant investment philosophies—played down the low expense of a recent fund, urging investors to instead focus on other issues like spreads and tax efficiency.