Are Investors Paying Lower--or Simply Different--Fees?

Karen Wallace: From Morningstar, I'm Karen Wallace. Investors paid less to own funds in 2018 according to new Morningstar research. Here to discuss it is Ben Johnson. He's global director of ETF research at Morningstar.

Ben, thanks for being here.

Ben Johnson: Thanks for having me, Karen.

Wallace: So we've done this fee study since 2000, which is a while now. What are some of the longer-term trends that we've seen?

Johnson: What we've seen over a very long period of time is that fees have been marching lower and marching consistently lower since we started looking at U.S. fund fees in 2000. So, in each of the past 18 years is what we've seen is a decline in the asset-weighted fee that's been levied among U.S. funds. Now the asset-weighted fee is a reflection of how much investors are paying as opposed to what funds might be charging. So, if you look back all the way to 2000 and fast-forward to the end of last year, at the end of 2018 investors were paying half as much on average to invest in funds than they were in 2000. If you go back just five years, what we've seen is a 26% decline in the asset-weighted expense ratio across all U.S. funds.

Wallace: The decline from 2017 to 2018 was something like the second-largest decline we've ever seen. It was 6%, which works out to something like $5.5 billion in cost savings. How does that break down?

Johnson: Well, if you look at the decline in the asset-weighted fee, you are exactly right--having fallen from 0.51% in 2017 to 0.48% last year reflects a 6% decline. As you mentioned, the second-largest percentage decline in the asset-weighted fee we've seen dating back to 2000, amounting to $5.5 billion worth of fee savings for investors in 2018. If you distill that down, given that this is the asset-weighted average expense ratio, it inherently reflects investors' preferences. And the preference that is abundantly clear and has been clear for some time now is that investors are moving to less-costly funds. So we looked at flows into funds on the basis of their costs. Separating them out into 20% chunks across the fee spectrum. So, the lowest-cost quintile, or the cheapest 20% of funds, amassed all of the net new money last year--just over $600 billion worth of net new flows. So, fees are being driven lower, and investors are the ones who are in the driver's seat, with their hands on the wheel, and they are pointed firmly in the direction of inexpensive funds.

Wallace: That sounds like a good thing. What are some of the things that are driving investors toward lower-cost funds? Is it purely their own choice, or is it just the evolving advisor landscape?

Johnson: There is a variety of different factors that are at play here, that are moving investors toward cheaper options. One of them is just a growing awareness of the importance of fees--that every penny that you can save on investment costs is not just a penny earned, but a penny that can be saved and invested and compounded from here until the time that you want to withdraw that penny, which has become multiple pennies further down the road to fund your long-term goals. So, the importance of costs in the investor success equation, I think, has come into ever-sharper focus with time. The other important trend that's driving investors toward these less-costly options is a shift in the economics of advice, whereby advisors are moving away from being paid on commission to charging fees for their services. And that movement toward a fee-based business model is leading to a shift in preferences as it pertains to the funds that they select and build portfolios with on behalf of their clients. As more and more of the economics of that relationship shift to an advice fee, they are getting squeezed out of the investment products that advisors are recommending to their clients.

So, from an investor's point of view, it may actually be somewhat premature to do a victory lap and celebrate all of the billions upon billions of dollars that we've saved on fund fees over the years and to ask some pointed questions as to understand whether or not there is air being let out of the balloon or simply squeezing one side of the balloon in the form of fund fees and pushing all the air to the other side and it's simply staying within the balloon but just turning into advice costs, explicit fees, hourly fees, you name it. So, investors should be happy, they are paying less, in theory they are pocketing more. But take a step back--take a more holistic view of the total cost of investing--to understand whether or not it's really time to pop the champagne and pull out the party hats.

Wallace: That's great advice. And it was an interesting report. Thanks so much for being here to discuss it.

Johnson: Thanks for having me.

Wallace: From Morningstar, I'm Karen Wallace.