Fund Fees Are Coming Down
Which funds cut expense ratios the most?
Which funds cut expense ratios the most?
This article first appeared in Morningstar FundInvestor.
Just-published data show that expense ratios, which tell you what a fund charged investors during the most recently completed fiscal year, have come down for three straight years.
Consider that the average individual investor paid 0.93% for U.S. stock funds in 2006 compared with 0.96% in 2005. That's great news because expenses play a vital role in determining the outcome of a long-term investment.
This marks the third year in a row of meaningful expense ratio drops. That's a big deal because during the 1990s, assets grew sevenfold yet expense ratios barely budged as middlemen and fund companies kept all the economies of scale for themselves. You can see this in the table--little happened from 1991 to 2001.
Expense Ratio Trends over the Past 15 Years | ||||||
Broad Category | Type | 1991 Asset-Wgt Expense Ratio ( % ) | 1996 Asset-Wgt Expense Ratio ( % ) | 2001 Asset-Wgt Expense Ratio ( % ) | 2005 Asset-Wgt Expense Ratio ( % ) | 2006 Asset-Wgt Expense Ratio ( % ) |
Domestic Stocks | Individual | 1.04 | 1.03 | 1.03 | 0.96 | 0.93 |
Domestic Stocks | Institutional | 0.83 | 0.81 | 0.74 | 0.68 | 0.65 |
Domestic Stocks | All Funds | 1.00 | 0.98 | 0.96 | 0.88 | 0.84 |
Balanced | Individual | 0.96 | 0.97 | 0.90 | 0.82 | 0.79 |
Balanced | Institutional | 0.84 | 0.84 | 0.70 | 0.64 | 0.62 |
Balanced | All Funds | 0.94 | 0.95 | 0.86 | 0.78 | 0.76 |
International Equity | Individual | 1.24 | 1.32 | 1.27 | 1.13 | 1.07 |
International Equity | Institutional | 1.31 | 1.11 | 1.02 | 0.98 | 0.94 |
International Equity | All Funds | 1.25 | 1.27 | 1.19 | 1.08 | 1.02 |
Taxable Bonds | Individual | 1.06 | 0.99 | 0.91 | 0.84 | 0.81 |
Taxable Bonds | Institutional | 0.59 | 0.64 | 0.60 | 0.54 | 0.53 |
Taxable Bonds | All Funds | 1.01 | 0.91 | 0.80 | 0.72 | 0.69 |
Municipals | Individual | 0.70 | 0.77 | 0.74 | 0.75 | 0.75 |
Municipals | Institutional | 0.58 | 0.59 | 0.49 | 0.44 | 0.42 |
Municipals | All Funds | 0.68 | 0.75 | 0.69 | 0.67 | 0.66 |
All Funds | Individual | 0.97 | 1.01 | 1.01 | 0.93 | 0.91 |
All Funds | Institutional | 0.74 | 0.80 | 0.73 | 0.68 | 0.66 |
All Funds | All Funds | 0.93 | 0.97 | 0.94 | 0.86 | 0.83 |
The trend continued in most asset classes. The biggest price break came in international funds where big returns have spurred big inflows. The average individual investor paid 1.07% for international funds in 2006 compared with 1.13% in 2005. Balanced funds' expenses fell from 0.82% to 0.79%, while taxable bond expenses dipped from 0.84% to 0.81%. Once again, though, municipal-bond funds held fast at 0.75%, reflecting the fact that costs are already low but also that advisors may be choosing the highest-yielding funds over the lowest-cost funds. In addition, they haven't attracted much money of late so fewer fee breakpoint triggers have been hit.
Why Expense Ratios Change
Most funds' expense ratios change every year, though they tend to move in very small increments. The main reason for a change is simply that assets grew or fell to the point where the fund realized cost savings or lost some cost savings.
Most funds have breakpoints on management fees that cause expenses to fall as assets grow because running a mutual fund is a scalable proposition. A 50% increase in assets doesn't necessitate a 50% increase in managers, analysts, and traders.
Another way in which a fund's expense ratio changes is performance fees, which reward or punish fund management based on performance versus an index. A typical fee would add or subtract up to 20 basis points (a basis point equals 0.01%) based on how a fund performs versus the S&P 500 over a rolling three-year period.
The third source of change is when a fund changes the underlying fee structure. It's not uncommon to see changes to the management fee, changes to the breakpoints, or changes to some other fees that are components of the expense ratio such as the transfer fee.
Why Expense Ratios Are Falling
The overwhelming driver of falling expense ratios is rising assets. A market rally led assets to appreciate and of course drew billions of dollars into funds. That meant many funds hit various fee breakpoints and expense ratios have come down.
Cuts to underlying expense ratios are much less common but do have a positive effect. As punishment for market-timing and other transgressions, former New York Attorney General Eliot Spitzer forced a number of fund companies to lower their fees. That in turn led other fund companies not caught in the scandal to lower their fees because they base their fees on category averages.
Prominent Funds with Big Fee Cuts
Matthews India's (MINDX) expense ratio fell sharply from 2.00% to 1.41%, thus significantly improving its appeal. Big inflows to the fund are responsible for the cut. I'm excited because most funds dedicated to hot markets such as India and China are horribly overpriced, but here you can get one of the best Asia managers at a reasonable price.
Clipper (CFIMX) slashed expenses by 49 basis points to 0.62% because Chris Davis and Ken Feinberg charge a much lower management fee than their predecessors.
Fidelity International Real Estate (FIREX) saw expenses fall due to big inflows. This is no surprise because it's on top of the two hot trends in investing overseas and in real estate. That's a bit trendy for me, though, so I'd wait for it to get less trendy before buying.
Primecap Odyssey Growth (POGRX), Primecap Odyssey Aggressive Growth (POAGX), and Primecap Odyssey Stock (POSKX) have aggressive breakpoints to fees, which means that modest inflows led to big expense ratio cuts. The three slashed expenses by 25 to 36 basis points and now charge between 0.89% and 0.99%.
Bridgeway Aggressive Investors 2 also benefited from aggressive breakpoints as John Montgomery's mid-growth fund cut expenses from 1.37% to 1.12%. The fund is based on growth-oriented quantitative screens, which have so far produced fine performance.
Who's Hiking Fees?
Not everyone joined the parade to lower fees. Interestingly, two of the lower-cost fund families, Fidelity and Vanguard, made the list.
Northeast Investors (NTHEX) had a huge expense ratio increase from 0.73% to 1.23%--but not to worry. The increase was due to use of leverage to meet redemptions. Funds have to include interest costs on loans in their expenses, so the fund's expense ratio popped up, but it should settle back down this year.
Fidelity Convertible Securities (FCVSX) and Fidelity Independence had their expense ratios rise for the best of reasons: They performed well, thus boosting their performance fee.
Janus Global Opportunities' expense ratio ticked up by 13 basis points because poor performance has led to redemptions.
Fidelity New Millennium (FMILX) also saw its expenses edge up due to redemptions. Some of those redemptions were a response to the departure of longtime manager Neal Miller. In fact, the fund just reopened in an attempt to stem net outflows.
Vanguard Mid Cap Growth (VMGRX) saw its expenses pop up 11 basis points because Vanguard replaced its management with new managers and agreed to pay the new managers a higher fee. We've seen Vanguard boost management fees at a number of actively managed funds in recent years.
A Virtuous Circle
Investors and advisors are increasingly turning to low-cost funds because some look closely at cost while others look at performance, and low-cost funds outperform the rest. Whatever the reason, the important thing is that the fund industry has momentum toward lower costs. There's plenty of room for fund companies to deliver greater efficiencies to investors, so it's certainly possible that the move to low-cost funds will spur more fee cuts.
In any case, there are scores of good low-cost funds for investors to choose from. So dig in, and don't settle for overpriced funds.
How You Voted in Foreign Small Value Poll
Two weeks ago, I asked "What do you plan to do with your foreign small-cap exposure?" And here's how you voted. 46% - Buy more. 5% - Sell more. 49% - Stand pat. Good to know that we contrarians won't have to fight the crowds.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.