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Investors Snub All But the Lowest-Cost Funds

Fund inflow data show that investors' preference for low-cost funds has been even stronger than expected.

Investors Snub All But the Lowest-Cost Funds

Alina Lamy: A quick look at flows into open-end funds by fee level can give us an idea about just how important cost has become to investors, especially in the equity and fixed-income categories.

Morningstar’s Fee Level data point evaluates a mutual fund share class's expense ratio relative to other funds that invest in a similar asset class and have similar distribution characteristics. Then the funds within each comparison group are ranked into quintiles by expense ratio, from low (meaning least expensive) to high (most expensive).

Analyzing trailing 12-month flows by asset class and fee level yielded some pretty staggering results. Sure, we would have expected to see higher flows into the low and below-average fee level categories, perhaps some flows into funds with average fee levels, and outflows from funds in the above-average and high fee level range. However, at least for equity and fixed-income funds, results are much more extreme than that. The only positive flows we’ve seen were only into the low fee level group, meaning the least expensive 20% of funds. Investors took money out of all the other funds that weren’t in the bottom 20% in terms of cost.

With alternative funds, however, the story changes; in fact, the story is exactly the opposite. Flows were positive for all fee levels except the lowest. In other words, investors took money out of the least expensive 20% of funds, and placed it with more expensive funds instead. It makes sense that fees are not the main driver of flows for the alternative category, though, because these strategies are much more complex, more diverse, and performance can vary widely, so investors pay much more attention to manager skill than to expenses.

Overall, it’s undeniable that cost is becoming an ever more crucial factor in the fund companies’ battle for investor assets. The overall industry landscape is shifting and participants will have to find new and creative ways to adapt and to stay competitive.

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