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The Incredible Shrinking Fee

How low can fund fees go?

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. The average expense ratio paid by fund investors has been falling for more than two decades. What does that mean for investors today? Joining me to discuss some of the key takeaways from Morningstar's new fund fee study is Ben Johnson. Ben is Morningstar's global director of ETF research.

Hi, Ben. Thanks for being here today.

Ben Johnson: Hi, Susan. Thanks for having me.

Dziubinski: Fund expense ratios continue to fall last year compared to the year prior. And that's continuing a long-standing trend. What do the numbers look like?

Johnson: Well, the numbers look favorable if you're an investor, certainly. So in 2020, the asset-weighted average fee--so, effectively the average fee paid by investors to invest in mutual funds and ETFs--came in at 0.41%. Now that was down from 0.44% in 2019. In dollars and cents, that amounted to effectively $6.2 billion collectively worth of fund fee savings, savings that were pocketed by investors and put back to work in the market, savings that will continue to compound to their benefit for the foreseeable future. Now, if we take a step back further, what we see is that 0.41% asset-weighted average fee is now less than half of what investors paid for funds going back two decades. So, there's been meaningful progress that's been made over the course of the past 20-plus years. And investors deserve a lot of the credit, because at the margin, what we've seen is that each incremental dollar that's coming into U.S. mutual funds and ETFs is going into the least costly funds, the least costly share classes of those funds.

Dziubinski: In your latest research, you do point out that these savings, these cost savings, have gone disproportionately to investors in passive funds. Let's unpack that a little bit.

Johnson: Yeah, so a lot of it just has to do with a broader shift toward passively managed funds and away from actively managed funds. Now, if we look a little bit more closely, what we see is that not all active funds have been losing money. And indeed, the least costly quintiles of the 20% of the cheapest actively managed funds and share classes of those funds has actually continued to garner inflows. So investors are really laser-focused on fees, investing in the cheapest 20% of funds, be they active, be they indexed. What's really interesting is when you look within that cheapest 20%, most of that money has actually been going to the cheapest 5% of all funds, so investors are as shrewd as ever when it comes to fund expenses.

Dziubinski: Now, you examined the relationship between fund flows and expenses. What were the results there?

Johnson: Well, really, that's what lets us know, loud and clear, that, at the margin, much of the decrease in the asset-weighted fee paid by investors has been a result of the shift from higher-cost funds to lower-cost funds and, to a lesser extent, actual either reactionary or proactive expense ratio reductions on the part of the asset managers themselves. So, investors can give themselves a pat on the back for selecting lower-cost funds of all types, and to a lesser extent, the asset managers get some credit. There have been some very meaningful steps taken by many asset managers to reduce expense ratios either in isolation or across their fund lineups over time. And in between the asset managers and individual investors, what we've seen is that one of the big trends that's been driving this as well is the evolution of the economics of advice.

And specifically, what we've seen is advisors moving increasingly from transaction-driven models of providing financial advice and building portfolios toward fee-based advisory models. So, fees are getting squeezed, and you're seeing that in what we're measuring within our fund fee study. What I would urge investors to understand is that, as fees are getting squeezed, are they just pushing air from one side of the balloon to another? Or is the air truly escaping the balloon? So in many cases, as investors shift to a fee-based advisory model, they may be paying just as much as they ever have, they might be paying more, they might be paying less. So I think it's important to celebrate, certainly, the victories at the level of fund fees, but it's incumbent upon investors to take a step back and understand more holistically: What is the price they're paying for financial advice? And not just: What are they paying for the funds that they're investing in?

Dziubinski: Given how far fees and expense ratios have fallen over the past two decades, what do you expect going forward?

Johnson: I expect a continuation of the trend, and certainly what we've seen over the course of the past decade or so is that that trend has really been relentless and indeed really accelerated. I expect that investors will continue to allocate toward lower-cost funds. I expect that asset managers will continue to experiment with different models of charging fees. And we've seen certain localized examples of things like loyalty-based fees or performance-based fees, which have kind of lived and died any number of times over the years and been experimented with by asset managers to varying degrees of success. I think the only inevitability, really, is that fees will probably continue to come down.

Now, that said, I think, looking forward, what investors need to realize is that, as fees continue to come down, they actually matter somewhat less in forward-looking terms, in terms of the returns that they can expect from the funds that they invest in. So, if I'm looking at three different funds that are each charging 5-basis-points worth of fees, fees don't matter at all because the fees are equal among the three and understanding those funds' processes, their strategies, the people that are applying those strategies, matters more so than ever. I would urge investors, again, to celebrate the fact that they're paying less in fund fees than ever but also to understand: As fees go lower, they probably matter less.

Dziubinski: Well, Ben, thank you for your time today and for giving all of us a little bit of perspective of what to make of falling fund fees. It's good news, and we hope it continues, but there are other things we should be looking at now, I see, besides just fees.

Johnson: Thanks so much for having me, Susan.

Dziubinski: I'm Susan Dziubinski. Thanks for tuning in.