Fund Fee Trends Continue to Benefit Investors

Christine Benz: Hi, I'm Christine Benz from Morningstar. Fund fees have been declining for two decades, and that trend has been accelerating in recent years. Joining me to provide some color on Morningstar's just-released fund fee study is Ben Johnson. He's Morningstar's director of global ETF research. Ben, thank you so much for being here.

Ben Johnson: Thanks for having me Christine.

Benz: So Ben, let's talk about the trend toward lower fees and put some historical context around it. You say that the asset, typical asset-weighted fee that investors pay, is the lowest that it's been since the turn of the millennium. Let's talk about where they were then, where they were 10 years ago, and how that compares to where we are today.

Johnson: Well, if you look at the asset-weighted average fee across all funds in 2019, it stood at 0.45%. And that is nearly half of what it was going back two decades ago. It's 38% lower than it was going back just one decade ago. So while this is a trend that's been in place now for about 20 years, it's really accelerated, it's gathered a head of steam over the course of the past 10.

Benz: So you look at average asset-weighted fees and there are really two components to that. One is that it's the fees that funds are charging, but also investor choice. And so let's talk about what has been the bigger driver of this trend toward lower asset-weighted fees.

Johnson: The biggest driver has been investor choice. It's been a very democratic process. Investors of all stripes have been voting with their investment dollars and allocating more of those at the margin towards lower-cost funds or lower-cost share classes. Now, if you look underneath the surface of the broader trend, there's some smaller trends afoot that have helped this to gather momentum.

One of those, I think very importantly, is an evolution we've seen in the advice space. Most notably the evolution of the economic model of advice is more and more advisors have moved from transaction-driven commission-based models of conducting their business, toward fee-based advice models. They've preferred to use lower-cost funds on behalf of their clients. They've also been generally preferring to use lower-cost share classes--share classes that don't have embedded in their fees some component that goes to compensating the advisor, and not necessarily the portfolio manager or the asset manager that's manufactured that investment product.

The other important trend we've seen is the evolution of the retirement savings space. And increasingly what you see is that many Americans in their 401(K) plans are opting into a default option that oftentimes is a target-date fund that's made up of very low-cost index mutual funds, which now comprise the majority of all target-date fund retirement assets. So these two big trends, one in the advice space the other and the retirement space, I think are further adding fuel to just a general widespread adoption of investors preferring low-cost funds. And a lot of that has to do with the fact that the cat's out of the bag, that investors more broadly are realizing that every penny they pay out in fees is a penny that goes to someone else. It doesn't compound to their own benefit between now and whenever they are going to withdraw those funds to spend against their long-term goals.

Benz: One cautionary note that you sounded in the report was that even though fund fees paid by investors have been declining, all-in fees may not necessarily be declining. So let's talk about that aspect of this trend.

Johnson: I think it's important that investors understand that not all of these fees are just simply dissipating. They're not evaporating into the atmosphere. They're not necessarily pocketing each and every penny that's come out of fund fees. Some of these fees might be, in certain circumstances, simply getting displaced. And I think most prominently, this could be the case in certain advisory relationships. So for those investors who were working with an advisor, some of the fees that they may have been paying directly in the form of fund fees, may actually just be going from one pocket to another, and now getting paid out as advice fees. So I think it's important that investors ask pointed questions of their advisors. Ask them how they're getting paid, how much they're getting paid and what exactly they're paying them for to understand how much of these headline savings are actually accrued to their benefit.

Benz: We've seen this market sell off certainly in the first quarter, the market recovered now some volatility again. How do you expect that to affect the trend toward lower-fee funds?

Johnson: I think the sell-off we've seen in the first quarter of this year, if anything, might only further accelerate this trend. Effectively what the downdraft in the market did was give many investors a "get out of jail free" card of sorts. There are many investors that for years now, in a long bull market, had been locked up in positions and funds where they have large embedded taxable gains. We saw many investors take the opportunity that was presented to them, as painful as it might've been, to sell some of those positions during the market downdraft to realize some tax losses in the process, and reallocate some of that money towards lower-cost funds. So if anything, I think at the margin episodes like we experienced in the first quarter of 2020 serve to only further accelerate this trend towards lower-cost funds.

Benz: What do you think the future holds in this space? Do you think that the excess has been rung out already? Or do you think that there's more gas left in the tank in this trend toward lower fund fees?

Johnson: I think there's still plenty of gas left in the tank, Christine. Certainly if you look out over the funds landscape, there's billions of dollars that are still invested in relatively high-cost funds, which isn't necessarily bad. There are funds out there that deliver value for their investors, and take a fair share in fees. But nonetheless, I think this trend will only continue. I think many funds will have to take a long, hard look at their fees to be competitive and ultimately cut them. And what we're seeing also is that more and more asset managers are experimenting with a variety of different things. On the one hand, we're seeing experimentation in the form of different fee structures, be those performance-based fees, or in some cases more recently effectively a loyalty fee program, whereby fees will ratchet lower for investors each year that they hold a given fund.

On the other hand, we're seeing asset managers experiment with new formats. Notably this year, we've seen a raft of new launches of actively managed non-transparent ETFs, which are much more fee-efficient and potentially much more tax-efficient than traditional open-ended mutual funds. So I think the trend that's been in place now for the past two decades will only continue, and I think the asset management industry will continue to evolve. And I think net net, the benefit will continue to accrue to investors as asset management firms compete for their hard-earned savings. Investors have a lot to celebrate.

Benz: Ben, lots of data, lots of research packed into this report. Thank you so much for being here to discuss it with us.

Johnson: Thanks for having me.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.