A new study from Morningstar shows that expense ratios are dropping. The study shows that asset-weighted expense ratios dropped to 0.64% in 2014 from 0.65% the year before and 0.76% in 2009. Over the past ten years, the asset-weighted expense ratio has declined 27%, while assets under management have increased 143%. As a result of this strong growth, industry fee revenue in dollar terms actually grew from $50 billion to $88 billion over the past ten years.
The report posits that the downward trend in expense ratios is due to breakpoints that are being hit due to a bull market and net positive flows. Morningstar also points out that adviser fees dropped only one basis point in the five-year period, and thus the decline in overall expense ratio is attributable to other fees such as those for distribution and administration.
The five-year change in expense ratios is even more pronounced when focusing on the U.S. equity sector, which shaved 17 basis points to an asset-weighted expense ratio of 0.58% in 2014. Taxable bond funds showed the lowest five-year change, dropping just four basis points to 0.56%, though that level matches municipal bonds for the lowest expense ratios. Only the alternatives sector increased expense ratios over the period, adding seven basis points to end at 1.31%. However, during the time period, alternatives added market share of 0.2 percentage points to end at 1.4% of total assets, despite the sector losing share in passively managed assets from 45.9% to 22.5%.
Investors have driven the change, according to the report. Mutual funds and exchange-traded products with expense ratios in the lowest quintile saw net inflows of more than $3 trillion, vastly outpacing the $160 billion of net inflows for other funds. Index funds, which are more likely to be found in the lowest quintile, saw net 2014 inflows of $392 billion versus $66 billion for active funds, and now represent 28% of total assets (up from 13% ten years ago). Passive funds had an asset-weighted expense ratio of 0.20% in 2014, whereas active funds averaged 0.79%, according to Morningstar.
In addition to investors moving into lower cost funds, they have also shown a preference for lower cost share classes. Advisers are increasingly using omnibus accounts and fee-based advisers are steering clients to ETFs or no-load shares (for fees outside of the scope of the report). While load share classes represented 37% of assets in 2004, they held 20% of market share in 2014.
A New York Times commentary on the report can be found here.