With all the talk about how fees can negatively impact investment returns, particularly over the long run, it's nice to see the new research showing that mutual fund fees have started to come down. According to a recent article in Morningstar magazine (March, 2015), the average investor in open-ended mutual funds paid 0.71% in expenses in 2013 versus 0.72% in 2012, 0.78% in 2010, and 0.95% in 2000. There are a few explanations for this investor-friendly trend, and many of them point to this pattern continuing into the future.
Perhaps the most obvious explanation for this is an increased investor awareness of fees and the impact that they can have on returns. In previous decades, when the main focus was on fund performance, investors may not have given much thought to the internal cost of a mutual fund. But today investors are growing more aware of alternative investment products and platforms that charge less to accomplish similar goals. That awareness likely stems from a combination of advertising, social media, and actual disclosures, which financial services firms provide to their customers to explain the costs of fund ownership.
We've also been seeing regulators such as the Securities and Exchange Commission (SEC) and the Department of Labor (DOL) digging deeper into certain practices that may be keeping mutual fund fees higher than they need to be. One example of this is the 12b-1 fee, an internal mutual fund expense that covers the marketing and distribution costs that may be incurred by the fund provider. In an era where transparency is key, reducing or eliminating these sorts of fees, which are unknown or misunderstood by some investors, may continue to be a priority for the regulators.
Another interesting trend that may be helping to bring down fund expenses is the substantial growth in mutual fund assets caused by rising equity prices over the past few years. The reason for that revolves around the breakpoint schedules followed by many mutual fund companies. Breakpoints refer to cost reductions offered by mutual fund providers for each dollar managed above certain asset-under-management thresholds. As those asset levels continue to rise, expense ratios tend to tick lower. Related to that, and highlighted in the 2015 Investment Company Fact Book, is the point that many of the expenses charged by mutual funds, such as transfer agency fees and accounting and audit fees, are fixed-dollar costs, not percentages of the fund's assets. As a result, as a fund's asset levels continue to rise, these costs contribute less to the fund's expense ratio.
Rising equity markets may lend themselves to lower mutual fund fees, but it doesn't seem likely that investors will tolerate rising fees during a bear market. The potential for declining account values may cause investors to focus in more on factors that they can control, such as cost. There are many investors who believe that, when screening for investments, cost should be the first, not the last, factor to consider.
That’s why competition may be one of the most important factors bringing down mutual fund fees. The Investment Company Fact Book notes that competition for investor dollars is not only among mutual fund companies. It’s also coming from providers of exchanged-traded funds (ETFs). ETFs provide an appeal and value proposition that’s similar to mutual funds, including broad diversification and exposure to various asset classes and market sectors. However, many ETFs utilize a passive, index approach to investing, which can come with substantially lower expenses. As we pointed out in an earlier discussion on ETFs, these vehicles can provide investors with exposure to an index such as the S&P 500 for as little as 0.05% per year.
Fee awareness is particularly relevant in the mutual fund realm because of how prevalent mutual funds are in both the retirement and non-retirement space. Many 401(k) platforms offer only mutual fund options, so getting those costs under control is a serious issue that impacts many investors’ ability to accumulate money for their life goals. Many investors are looking for alternative.