Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton. Many investors are ditching expensive funds for cheaper ones to save on fees. And it’s working. The trend has pushed average expense ratios to a record low. That’s according to a Morningstar study. Bryan Armour is the director of passive strategies research for North America for Morningstar Research Services. He’s also the editor of the Morningstar ETF Investor newsletter.
Thanks, Bryan, for joining me today. So, your team looked at fund fees over a long period. Can you tell us what you found? What are some of the highlights?
Bryan Armour: Yeah. So, in the last 20 years, we've seen the average asset-weighted expense ratio for open-end mutual funds and ETFs drop from 91 basis points to 37. And so, that's a big win for investors. It's a trend that's been continuing year-over-year. It's a lot smaller changes to get to that 20-year large number. But in the equal-weighted average expense ratio, we see still at 91 basis points. So, that's the average fund what they are charging versus what's the average investor paying in asset-weighted funds. So, there is still more room to cut based on that 91-basis-point fee. But yeah, it's been shrinking, which is great.
Hampton: So, what was your reaction when you saw the growing gap between money going into cheap funds and leaving expensive ones?
Armour: It wasn't a surprise. Perhaps the extent was. We saw in similar fund flow trends going out of more expensive mutual funds into ETFs. And in the same way here, we saw the cheapest quintile funds actually pull in $400 billion worth of new investor money, whereas the other 80% saw outflows of $700 billion. So, it's a $1.1 trillion gap between the cheapest quintile and the most expensive. So, that was huge, big difference. With 2022, there was a lot that went into that both by virtue of performance issues. It was a tough market. There's a lot of investors moving away from more speculative assets and going back to the basics.
Hampton: So, the trend of falling fund fees involves both passively managed and actively managed funds, right?
Armour: Definitely. Yeah.
Hampton: And there are a few factors pushing down costs. Let's start with investors. How are they driving fees lower?
Armour: Yeah. So, when we talk about asset-weighted average fee, it depends where those assets are. And so, investors – Russ Kinnel, Morningstar's long – had research that proves the efficacy of low costs in predicting future returns. And so, it's the best predictor. And so, investors are increasingly aware of that. They're buying lower-cost funds. And that just by virtue of switching to lower-cost funds is pushing the asset-weighted average fee down significantly. So, it's a big win for investors.
Hampton: So, what's happening with retirement accounts?
Armour: Yeah. Same thing. Same thing as everywhere else, really. Target date funds are becoming increasingly cheap and taking more and more market share. We've seen a shift from mutual funds to collective investment trusts, which are – CITs have a little less regulatory scrutiny and they're allowed to negotiate fees with retirement plan sponsors. So, that helps bring down costs, although a little bit of a trade-off with a loss of transparency there.
Hampton: And the third factor involves the financial advice industry. Describe the shift that's happening there.
Armour: Yeah. So, advisors have switched from commission-based to fee-based model of how they get paid. So, the fees aren't coming through the fund anymore. It's coming through a set fixed fee that they agree on with the investor. And so, over time, you think of bundled funds, it's like the old traditional mutual fund where you pay a load and there's 12b-1 fees and those fees are taken by the mutual fund company and paid out to distributors and advisors. So, basically, that's just switched to a fixed fee for advice. And then the advisors tend to go with the cheaper funds because they don't want to layer high-fee funds on top of their own fee and they're aware of the efficacy of low-cost funds. So, they choose those. It's an easy choice for them for their clients.
Hampton: So, why might an investor not see savings if they're working with an advisor?
Armour: Yeah. So, if you switch from expensive funds to lower-cost funds, but now you're charging a fixed fee for advice, then maybe you don't get to capture all that because of the fixed fee is what you're going to be paying. So, it's always good to look at the full cost of advice when you're thinking about that.
Hampton: And investors in sustainable funds are paying a so-called greenium. Can you explain what that is and how their fees compare to others?
Armour: Yeah. So, they are cheaper overall than a lot of other funds, but anytime you add some sort of tilt away from the market cap index, fund issuers add a fee. So, there are ETFs that track an index without ESG, and then they add an ESG layer to it, and then that other fund is at a slightly higher price. And so, we've seen that pattern that premium exists for ESG funds, but it is converging with the asset-weighted average fund fee as well. So, it's shrinking.
Hampton: So, your research – you and your team – your research found that Vanguard held onto the top spot for cheapest average fund fees. So, my question to you guys is, who's the closest to catching them?
Armour: Yeah. So, I had split out iShares and BlackRock this year. I think they operate as two distinct business units at this point. iShares is so important to the ETF market that it just made sense. So, iShares and State Street are as close as you – they're still like double Vanguard, but as close as anyone else. And a more shocking one is Dimensional Fund Advisors is pretty hot in their heels as well, and that's an active manager. But that's a big reason why they've become the largest issuer of active ETFs.
Hampton: So, earlier, we've talked about how fund fees had dropped a lot over a couple of decades. How low do you think fund fees can go?
Armour: Well, it depends, I think, is the short answer. If you look at commoditized indexes like the S&P 500, there's obviously not a lot of room to go. But they're still instead of the broad fee wars that used to exist, we're seeing more fee skirmishes break out across the fund landscape. And so, two that come to mind are BlackRock entered the Buffer ETF market. Buffer ETFs provide some downside protection, give up upside like a covered call strategy, but they use options and they became really popular in 2022. BlackRock saw that and came in and undercut the largest issuers in that space by 30 basis points and they're charging 50 whereas the other ones are 80. And so, that's an example of where we're seeing these fee wars continue to play out. Another one being Schwab put out their first High Yield Bond ETF and they've matched the lowest cost fund on the
market, and that was a State Street ETF for 10 basis points. There was no one really close to either of them. But by the end of the month, State Street cut their fee from 10 to 5 basis points. So, it's still happening. I think you'll see it in crypto, especially if the SEC approves Ethereum Futures ETFs and then potentially with Spot Bitcoin, there could be massive competition there. So, there's a lot more to go.
Hampton: So, can you name some top picks among the funds and ETFs that had the biggest fee cuts?
Armour: Yeah. So, two off the bat – Vanguard last year had cut fees on the international ETFs. And so, the Vanguard International Dividend Appreciation ETF, VIGI, is a great fund, and that's one that dropped its fee a solid amount, 5 basis points. And then, similarly, Vanguard International High Dividend Yield ETF, VYMI.
Hampton: All right. Well, Bryan, thank you for joining me today to talk about falling fund fees.
Armour: Thanks for having me.
Hampton: Thanks to senior video producer Jake VanKersen. And thank you for tuning into “Investing Insights.” Subscribe to Morningstar’s YouTube channel to see new videos from our team. You can hear market trends and analyst insights from Morningstar on your Alexa devices. Say ‘Play Morningstar’. I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.
