Fund expense ratios continue to fall as fund companies get richer

Flood of money into passively-managed index funds has helped drive average expense ratios down, but there's more to the story.

Mutual fund investors are paying lower fees while asset managers are enjoying higher revenues in a scenario likely to only get rosier.
An analysis of the expense ratios charged by mutual funds and exchange-traded products shows that investors are paying 27% less in fees than they were 10 years ago, according to Michael Rawson, an analyst with manager research at Morningstar Inc.
Measuring fees on an asset-weighted basis, which factors in those funds that are most popular with investors, Mr. Rawson found that the average expense ratio across the universe of more than 22,000 investment products is just 64 basis points. That compares to an average asset-weighted expense ratio of 84 basis points 10 years ago.

Source: Morningstar Inc.

That is a far cry from the oft-touted 1.9% average expense ratio that comes from calculating fees on an equal-weighted basis, which averages fees across all funds and gives disproportionate weight to small funds with outsized expense ratios.
“Over the past decade, 95% of all flows have gone into funds in the lowest-cost quintile,” Mr. Rawson said.
The flood of money into passively-managed index funds has helped drive average expense ratios down, but Mr. Rawson said that isn’t the only factor influencing the declining expense ratio.

Source: Morningstar Inc.

SUCCESS BREEDS SUCCESS
“The lower average expense ratios is not just due to the fact that people are going to passive funds,” Mr. Rawson explained.
(More: In the battle between active and passive management, which style wins?)
“Most investors tend to pick pretty good funds, and as people put more and more money into low-cost funds it brings down that asset-weighted average expense ratio,” he said. “People are looking at fees, of course, but those funds that are successful tend to also lower fees over time. Ultimately, success breeds more success.”
And that success translates into revenue growth for the asset management industry, which has seen revenues surge 78% over the past 10 years to $88 billion in 2014, compared with $49.5 billion at the end of 2004.
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“While asset-weighted expense ratios have fallen, strong market appreciation and moderate inflows have pushed industry assets to record levels,” Mr. Rawson said, adding that “a much larger share of the benefits of the increase in assets under management has stayed with the industry rather than being returned to fund shareholders.”
Industry assets under management over that same 10-year period grew by 143% to $13.8 trillion, from $5.7 trillion.

Source: Morningstar Inc.