Investors paid less to own mutual funds and ETFs in 2016, but the impact of the Department of Labor’s fiduciary rule has not yet been felt, according to a recent report.
While a massive amount of assets has flowed out of traditional mutual funds in recent years, not all funds are sharing the same fate, according to recent research from the Washington-based Investment Company Institute (ICI). In the most recent ICI Research Perspectives, an annual analysis of fund flows and expense ratios, no-load mutual fund share classes enjoyed $113 billion of net inflows during 2016, while approximately $232 billion flowed out of load mutual fund share classes.
In 2016, the ICI attributed most of the average expense ratio reductions to the shift toward low-cost, efficient and passive investing strategies, including a preference for no-load share classes. The movement away from commission-based compensation models and towards fee-based or fee-only financial planning has also contributed to the downward trend in expense ratios. Nevertheless, the ICI says that the impact of the Department of Labor’s fiduciary rule on expense ratios has thus far been “coincidental.”
Even through the industry’s crescendo of concern over the fiduciary rule in 2016, average expense ratio reductions across asset classes did not greatly exceed those recorded in recent years. For example, the average equity mutual fund expense ratio declined 4 basis points in 2016, the same decline reported in 2014, 2011, 2010 and 2009.
Index mutual funds and ETFs now account for 27.2 percent of the total assets in the fund universe, according to the ICI, dramatically increasing from 2005. With many market participants now favoring inexpensive, simple investment solutions, the movement towards no-load share classes has caused expense ratios of both passive and active mutual funds to drop over time.
Since 1996, the average expense ratio of active equity mutual funds declined from 1.08 percent to 0.82 percent in 2016. Similarly, index mutual fund expense ratios fell from an average of 0.27 percent in 1996 to 0.09 percent in 2016.
The ICI has found that fee compression in the fund industry continues across most asset classes, following a persistent 20-year trend. In 2016, the average equity mutual fund carried a 0.63 percent expense ratio, down from 1.04 percent in 1996. Bond fund expense ratios fell from an average of 0.84 percent in 1996 to 0.51 percent in 2016, while hybrid mutual fund expense ratios fell from an average of 0.95 percent in 1996 to 0.74 percent in 2016.
Some of the decline can be attributed to asset growth, according to the ICI’s report, as expense ratios for many domestic equity mutual funds increased between October 2007 and March 2009 during the global financial crisis. As values plummeted and investors pulled assets out of the funds, fixed costs like director fees, audit fees and transfer agency fees made up a larger proportion of the fund expense ratios. As fund assets recovered after March 2009, expense ratios began to decline again.
According to the ICI’s report, the average expense ratio across equities, bonds and hybrid funds each declined by at least 3 basis points independent of asset growth. More than 50 percent of the share classes in the mutual fund universe changed their expense ratio in 2016.
The expense ratios of target-date funds dropped to an average of 0.51 percent in 2016, a decline the ICI attributes to their increased adoption as qualified default investments by 401(k) sponsors. Approximately 47 percent of the account balances of recently hired 401(k) participants in their 20s are in TDFs, thus as newly hired employees begin contributing to their 401(k), the average expense ratios of TDFs have declined.
The growth of 401(k)s also causes declining expense ratios, said the ICI, as participants investing in mutual funds via their workplace retirement plan typically hold lower-cost options.
Downward pressure on expense ratios is also affecting ETFs. Index equity ETF average expense ratios fell to 0.23 percent in 2016 from a 2009 peak of 0.34 percent. Index bond ETF expense ratios also declined to 0.20 percent from a 2013 peak of 0.26 percent.
Money market fund expense ratios were an outlier, as they increased in 2016 from 0.13 percent to 0.18 percent, according to the ICI, in response to a December 2015 increase in short-term interest rates implemented by the Fed.
For the numbers reported in this story, the ICI calculated the funds asset-weighted average expense ratios. The ICI found that mutual funds’ median and simple arithmetic average expense ratios to be significantly higher than their asset-weighted average, indicating that a much larger volume of assets is now held within lower-cost funds and that expense ratios continue to decline independent of growth in total assets. In its report, the ICI analyzed data released in May by Chicago-based Morningstar regarding fund expense ratios