Trends in Mutual Fund Expenses

Mutual fund investors incur two primary types of expenses and fees: ongoing expenses and sales loads. Ongoing expenses cover portfolio management, fund administration, daily fund accounting and pricing, shareholder services (such as call centers and websites), distribution charges (known as 12b-1 fees), and other operating costs. These expenses are included in a fund’s expense ratio—the fund’s annual expenses expressed as a percentage of its assets. Because expenses are paid from fund assets, investors pay these expenses indirectly. Sales loads are paid at the time of share purchase (front-end loads), when shares are redeemed (back-end loads), or over time (level loads).

On an asset-weighted basis, average expense ratios* incurred by mutual fund investors have fallen substantially (Figure 5.1). In 2000, equity mutual fund investors incurred expense ratios of 0.99 percent, on average, or 99 cents for every $100 invested. By 2016, that average had fallen to 0.63 percent, a decline of 36 percent. Hybrid and bond mutual fund expense ratios also have declined. The average hybrid mutual fund expense ratio fell from 0.89 percent in 2000 to 0.74 percent in 2016, a reduction of 17 percent. In addition, the average bond mutual fund expense ratio fell from 0.76 percent in 2000 to 0.51 percent in 2016, a decline of 33 percent.

* In this chapter, unless otherwise noted, average expense ratios are calculated on an asset-weighted basis, which gives more weight to funds with greater assets. It reflects where investors are actually putting their assets, and thus, better reflects the actual expenses, fees, or performance experienced by investors than does a simple average (weighting each fund or share class equally). ICI’s fee research uses asset-weighted averages to summarize the expenses and fees that shareholders pay through funds. In this context, asset-weighted averages are preferable to simple averages, which would overstate the expenses and fees of funds in which investors hold few dollars. ICI weights each fund’s expense ratio by its year-end assets.


Figure 5.1

Expenses Incurred by Mutual Fund Investors Have Declined Substantially Since 2000

Percent, 2000–2016

Figure 5.1

 

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Note: Expense ratios are measured as asset-weighted averages. Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, and Morningstar

Understanding the Decline in Fund Expense Ratios

Several factors help account for the steep drop in mutual fund expense ratios. First, expense ratios often vary inversely with fund assets. Some fund costs included in expense ratios—such as transfer agency fees, accounting and audit fees, and directors’ fees—are more or less fixed in dollar terms. That means that when a fund’s assets rise, these costs contribute less to a fund’s expense ratio. Thus, if the assets of a fixed sample of funds rise over time, the sample’s average expense ratio tends to fall (Figure 5.2).

Another factor in the decline of the average expense ratios of long-term mutual funds is the shift toward no-load share classes,* particularly institutional no-load share classes, which tend to have below-average expense ratios. In part, this shift reflects a change in how investors pay for services from brokers and other financial professionals (see Mutual Fund Load Fees).

* See no-load share classes.


Figure 5.2

Mutual Fund Expense Ratios Tend to Fall as Fund Assets Rise

Share classes of actively managed domestic equity mutual funds continuously in existence since 20001

Figure 5.2

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1 Calculations are based on a fixed sample of share classes. Data exclude mutual funds available as investment choices in variable annuities, index mutual funds, and mutual funds that invest primarily in other mutual funds.
2 Expense ratios are measured as asset-weighted averages.
Sources: Investment Company Institute, Lipper, and Morningstar

Mutual fund expense ratios also have fallen because of economies of scale and competition. Investor demand for mutual fund services has increased dramatically in recent years. From 1990 to 2016, the number of households owning mutual funds more than doubled—from 23.4 million to 54.9 million (Figure 6.1). All else equal, this sharp increase in demand would tend to boost mutual fund expense ratios. Any such tendency, however, was mitigated by downward pressure on expense ratios—from competition among existing mutual fund sponsors, new mutual fund sponsors entering the industry, competition from products such as exchange-traded funds (ETFs) (see chapter 3 and here), and economies of scale resulting from the growth in fund assets.

Finally, shareholders tend to invest in mutual funds with below-average expense ratios (Figure 5.3). The simple average expense ratio of equity mutual funds (the average for all equity mutual funds offered for sale) was 1.28 percent in 2016. The asset-weighted average expense ratio for equity mutual funds (the average shareholders actually paid) was far lower—just 0.63 percent.

Figure 5.3

Fund Shareholders Paid Below-Average Expense Ratios for Equity Mutual Funds

Percent, 2000–2016

Figure 5.3

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Note: Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, and Morningstar

Another way to illustrate this tendency is to examine how investors allocate their assets across funds. At year-end 2016, equity mutual funds with expense ratios in the lowest quartile held 75 percent of equity mutual funds’ total net assets, while those with expense ratios in the upper three quartiles held only 25 percent (Figure 5.4). This pattern holds for both actively managed and index equity mutual funds. Index equity mutual funds with expense ratios in the lowest quartile held 78 percent of index equity mutual fund assets at year-end 2016.

Figure 5.4

Assets Are Concentrated in Lower-Cost Mutual Funds

Percentage of total net assets, 2016

Figure 5.4

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Note: Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute and Morningstar

Understanding Differences in the Expense Ratios of Mutual Funds

Like the prices of most goods and services, the expense ratios of individual mutual funds differ considerably across the array of available products. The expense ratios of individual funds depend on many factors, including investment objective, fund assets, and payments to financial intermediaries.

Mutual Fund Investment Objective

Mutual fund expense ratios vary by investment objective (Figure 5.5). For example, bond and money market mutual funds tend to have lower expense ratios than equity mutual funds. Among equity mutual funds, expense ratios tend to be higher for funds that specialize in a given sector—such as healthcare or real estate—or those that invest in equities around the world, because such funds tend to cost more to manage. Even within a particular investment objective, mutual fund expense ratios can vary considerably. For example, 10 percent of equity mutual funds that focus on growth stocks have expense ratios of 0.71 percent or less, while the top 10 percent have expense ratios of 1.97 percent or more. This variation reflects, among other things, the fact that some growth funds focus more on small- or mid-cap stocks and others focus more on large-cap stocks. This is important because portfolios of small- and mid‑cap stocks tend to cost more to manage.

Figure 5.5

Expense Ratios for Selected Investment Objectives

Percent, 2016

  Investment objective10th
percentile  
Median90th
percentile
Asset-weighted
average
Simple
average
Equity mutual funds1 0.68 1.21 2.04 0.63 1.28
    Growth 0.71 1.15 1.97 0.77 1.23
    Sector 0.77 1.33 2.15 0.78 1.38
    Value 0.70 1.13 1.92 0.74 1.20
    Blend 0.41 1.01 1.83 0.39 1.06
    World 0.83 1.33 2.15 0.78 1.41
Hybrid mutual funds1 0.65 1.19 2.01 0.74 1.29
Bond mutual funds1 0.45 0.83 1.63 0.51 0.94
    Investment grade 0.35 0.70 1.51 0.37 0.79
    World 0.62 1.01 1.84 0.65 1.11
    Other taxable 0.49 0.90 1.75 0.65 1.01
    Municipal 0.48 0.78 1.58 0.54 0.91
Money market funds1 0.09 0.22 0.39 0.18 0.23
Memo:
Target date mutual funds2 0.37 0.84 1.52 0.51 0.89
Index equity mutual funds1 0.06 0.35 1.51 0.09 0.63

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1 Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
2 Data include mutual funds that invest primarily in other mutual funds, but exclude mutual funds available as investment choices in variable annuities. Ninety-seven percent of these mutual funds invest primarily in other mutual funds.
Note: Each fund’s share class is weighted equally for the median, 10th, and 90th percentiles. Data include index mutual funds but exclude exchange-traded funds (ETFs).
Sources: Investment Company Institute and Morningstar


Index Funds

An index fund generally seeks to replicate the return on a specified index. Under this approach, often referred to as passive management, portfolio managers buy and hold all, or a representative sample of, the securities in their target indexes. This approach to portfolio management is a primary reason that index funds—whether mutual funds or ETFs—tend to have below-average expense ratios. By contrast, under an active management approach, managers have more discretion to increase or reduce exposure to sectors or securities within their funds’ investment mandates. Active managers may also undertake significant research about stocks or bonds, market sectors, or geographic regions. This approach offers investors the chance to earn superior returns, or to meet other investment objectives such as limit downside risk, manage volatility, under- or over-weight various sectors, and alter asset allocations in response to market conditions. Active management, however, also tends to be more costly than management of an index fund.

Understanding Index Mutual Fund Expense Ratios

Growth in index mutual funds has contributed to the decline in asset-weighted average expense ratios of equity and bond mutual funds. From 2004 to 2016, index mutual fund assets grew nearly fivefold, from $554 billion to $2.6 trillion (Figure 5.6). Consequently, over the same period, index mutual funds’ share of long-term mutual fund assets more than doubled, from 9.0 percent in 2004 to 19.3 percent in 2016. Although assets in index bond and index hybrid mutual funds have grown in recent years, index equity mutual funds still accounted for the lion’s share (81 percent) of index mutual fund assets in 2016.

Index mutual funds tend to have below-average expense ratios for several reasons. First, the passive approach to portfolio management generally seeks to replicate the return on a specified index. In doing so, portfolio managers buy and hold all, or a representative sample of, the securities in their target indexes. This naturally lends itself to being less costly.

Second, index mutual funds tend to have below-average expense ratios because of their investment focus. Assets of index equity mutual funds are concentrated more heavily in large-cap blend funds that target US large-cap indexes, such as the S&P 500. Assets of actively managed equity mutual funds, on the other hand, are more widely distributed across stocks of varying capitalization, international regions, or specialized business sectors. Managing portfolios of mid- or small-cap, international, or sector stocks is generally acknowledged to be more expensive than managing portfolios of US large-cap stocks.

Figure 5.6

Total Net Assets and Number of Index Mutual Funds Have Increased in Recent Years

Billions of dollars; year-end, 2004–2016

Figure 5.6

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Note: Data exclude mutual funds that invest primarily in other mutual funds. Components may not add to the total because of rounding.

Third, index mutual funds are larger on average than actively managed funds, which, through economies of scale, helps reduce fund expense ratios. In 2016, the average index equity mutual fund was nearly four times as large as the average actively managed equity mutual fund (with $5.9 billion for index equity mutual funds and $1.5 billion for actively managed equity mutual funds).

Finally, index mutual fund investors who hire financial professionals might pay for that service out of pocket, rather than through the fund’s expense ratio (see Mutual Fund Load Fees). In contrast, actively managed mutual funds more commonly have share classes that bundle those costs into the expense ratio.

These reasons, among others, help explain why index mutual funds generally have lower expense ratios than actively managed mutual funds. Note, however, that both index and actively managed mutual funds have contributed to the decline in the average expense ratios of mutual funds (Figure 5.7). From 2000 to 2016, the average expense ratio of index equity mutual funds fell from 0.27 percent to 0.09 percent, while the average expense ratio for actively managed equity mutual funds fell from 1.06 percent to 0.82 percent. Over the same period, the average expense ratio of index bond mutual funds fell from 0.21 percent to 0.07 percent and the average expense ratio of actively managed bond mutual funds fell from 0.78 percent to 0.58 percent.

Figure 5.7

Expense Ratios of Actively Managed and Index Mutual Funds

Percent, 2000–2016

Figure 5.7

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Note: Expense ratios are measured as asset-weighted averages. Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, and Morningstar

The downward trend in the average expense ratios of both index and actively managed mutual funds reflects, in part, investors’ increasing tendency to buy lower-cost funds. Investor demand for index mutual funds is disproportionately concentrated in funds with the lowest costs. This phenomenon is not unique to index funds, however; the proportion of assets in the lowest-cost actively managed funds is also high (Figure 5.4).

Understanding Index ETF Expense Ratios

The trends in ETFs over the past decade have influenced asset-weighted average expense ratios of index equity and index bond ETFs. ETF total net assets have grown rapidly in recent years, from $301 billion at year-end 2005 to $2.5 trillion at year-end 2016 (Figure 1.1). During this time, ETFs have become a significant market participant, with assets now accounting for about 13 percent of total net assets managed by investment companies at year-end 2016. ETFs are largely index-based and registered with the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940. Actively managed ETFs and non–1940 Act ETFs represented only 3.6 percent of ETF total net assets at year-end 2016. As is true of index mutual funds, most of the assets in ETFs are in funds that focus on equities. Equity ETFs account for 80 percent of the total net assets of ETFs.

Part of the strong growth in ETFs is attributable to their compensation structure where investors compensate financial professionals by paying them an asset-based fee directly. Compensation to financial professionals for distribution or account servicing and maintenance will typically be paid by the investor directly.* Also, financial professionals often provide programs that offer investors a suite of ETFs suited to their investment goals. In such cases, investors would typically pay financial professionals an asset-based fee over and above the expense ratios of the ETFs in the suite of ETFs selected. Because ETFs are generally index funds, they typically have low expense ratios.

* Some ETFs bundle distribution fees in the expense ratio to cover marketing and distribution expenses. These fees are usually small, ranging between 0.01 and 0.05 percent.

Like mutual funds, shareholders tend to invest in ETFs with below-average expense ratios (Figure 5.8). The simple average expense ratio of index equity ETFs (the average for all index equity ETFs offered for sale) was 0.52 percent in 2016. The asset-weighted average expense ratio for index equity ETFs (the average shareholders actually paid) was less than half of that—just 0.23 percent. The same holds for index bond ETFs, with a simple average expense ratio of 0.31 percent in 2016 and an asset-weighted average expense ratio of 0.20 percent.

Figure 5.8

Expense Ratios Incurred by Index ETF Investors Have Declined in Recent Years

Percent, 2005–2016

Figure 5.8

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* Data for index bond ETFs are excluded prior to 2007 because of a limited number of funds.
Note: Data exclude ETFs not registered under the Investment Company Act of 1940 and ETFs that invest primarily in other ETFs.
Sources: Investment Company Institute and Morningstar

Additionally, index ETF expense ratios differ based on their investment objectives (Figure 5.9). Among index bond ETFs, for example, expense ratios tend to be higher for ETFs that invest in either foreign or high-yield bonds because such securities are typically more costly to manage than, for example, Treasury bonds. And even within specific investment objectives, expense ratios will vary among different index ETFs for a range of reasons. For example, not all index ETFs in a given investment objective rely on the same index and licensing fees ETFs pay to index providers, and so their expense ratios may differ.

Figure 5.9

Index ETF Expense Ratios for Selected Investment Objectives

Percent, 2016

  Investment objective10th
percentile  
Median90th
percentile
Asset-weighted
average
Simple
average
Index equity ETFs 0.14 0.48 0.95 0.23 0.52
    Blend 0.10 0.39 0.95 0.14 0.49
    Growth 0.08 0.25 0.65 0.20 0.34
    Value 0.09 0.35 0.65 0.22 0.34
    Sector 0.14 0.50 0.95 0.27 0.56
    World 0.25 0.55 0.85 0.35 0.55
Index hybrid ETFs 0.48 0.60 0.75 0.54 0.64
Index bond ETFs 0.09 0.24 0.63 0.20 0.31
    Corporate 0.07 0.13 0.25 0.11 0.17
    World 0.32 0.49 0.50 0.37 0.47
    Government 0.07 0.16 0.95 0.19 0.36
    High-yield 0.40 0.43 0.64 0.48 0.49
    Municipal 0.18 0.25 0.35 0.25 0.25
Memo:
Active equity ETFs 0.60 0.89 0.99 0.88 0.87

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Note: Each fund’s share class is weighted equally for the median, 10th, and 90th percentiles. Data exclude ETFs not registered under the Investment Company Act of 1940 and ETFs that invest primarily in other ETFs.
Sources: Investment Company Institute and Morningstar

Mutual Fund Fee Structures

Mutual funds often are categorized by the class of shares that fund sponsors offer, primarily load or no-load classes. Load classes generally serve investors who buy shares through financial professionals; no-load classes usually serve investors who buy shares without the assistance of a financial professional or who choose to compensate their financial professionals separately. Funds sold through financial professionals typically offer more than one share class in order to provide investors with alternative ways to pay for financial services.

12b-1 Fees

Since 1980, when the US Securities and Exchange Commission adopted Rule 12b-1 under the Investment Company Act of 1940, mutual funds and their shareholders have had the flexibility to compensate financial professionals and other financial intermediaries through asset-based fees. These distribution fees, known as 12b-1 fees, enable investors to pay indirectly for some or all of the services they receive from financial professionals (such as their broker) and other financial intermediaries (such as retirement plan recordkeepers and discount brokerage firms). Funds also use 12b-1 fees to a very limited extent to help defray advertising and marketing costs.

Load Share Classes

Load share classes include a sales load, a 12b-1 fee, or both. Sales loads and 12b-1 fees are used to compensate brokers and other financial professionals for their services.

Front-end load shares, which are predominantly Class A shares, were the traditional way investors compensated financial professionals for assistance. These shares generally charge a sales load—a percentage of the sales price or offering price—at the time of purchase. They also generally have a 12b-1 fee, often 0.25 percent (25 basis points). Front-end load shares are sometimes used in employer-sponsored retirement plans, but fund sponsors typically waive the sales load for purchases made through such retirement plans. Additionally, front-end load fees often decline as the size of an investor’s initial purchase rises (called breakpoint discounts), and many fund providers offer discounted load fees when an investor has total balances exceeding a given amount in that provider’s funds.

Back-end load shares, often called Class B shares, typically do not have a front-end load. Investors using back-end load shares pay for services provided by financial professionals through a combination of an annual 12b-1 fee and a contingent deferred sales load (CDSL). The CDSL is paid if fund shares are redeemed before a given number of years of ownership. Back-end load shares usually convert after a specified number of years to a share class with a lower 12b-1 fee (for example, Class A shares). The assets in back-end load shares have declined substantially in recent years.

Level load shares, which include Class C shares, generally do not have front-end loads. Investors in this share class compensate financial professionals with an annual 12b-1 fee (typically 1 percent) and a CDSL (also typically 1 percent) that shareholders pay if they sell their shares within a year of purchase.

No-Load Share Classes

No-load share classes have neither a front-end load nor a CDSL, and have a 12b-1 fee of 0.25 percent (25 basis points) or less. Originally, no-load share classes were sold directly by mutual fund sponsors to investors. Now, investors can purchase no-load funds through employer-sponsored retirement plans, discount brokerage firms, and bank trust departments, as well as directly from mutual fund sponsors. Some financial professionals who charge investors separately for their services, rather than through a load or 12b-1 fee, help investors select a portfolio of no-load funds.

Mutual Fund Load Fees

Many mutual fund investors engage an investment professional, such as a broker, an investment adviser, or a financial planner. Among households owning mutual fund shares outside employer-sponsored retirement plans, 80 percent own mutual fund shares through investment professionals (Figure 6.10). These professionals can provide many benefits to investors, such as helping them identify financial goals, analyzing an existing financial portfolio, determining an appropriate asset allocation, and (depending on the type of financial professional) providing investment advice or recommendations to help investors achieve their financial goals. The investment professional also may provide ongoing services, such as responding to investors’ inquiries or periodically reviewing and rebalancing their portfolios.

Over the past few decades, the way that fund shareholders compensate financial professionals has changed significantly, moving away from front-end loads toward asset-based fees. One important outcome of the changing distribution structure has been a marked decline in load fees paid by mutual fund investors. The maximum front-end load fee that shareholders might pay for investing in mutual funds has changed little since 1990 (Figure 5.10). But front-end load fees that investors actually paid have declined markedly, from nearly 4 percent in 1990 to around 1 percent in 2016. This in part reflects the increasing role of mutual funds in helping investors save for retirement. Funds that normally charge front-end load fees often waive load fees on purchases made through defined contribution (DC) plans, such as 401(k) plans. Also, front-end load funds offer volume discounts, waiving or reducing load fees for large initial or cumulative purchases (see Mutual Fund Fee Structures).

Figure 5.10

Front-End Sales Loads That Investors Pay Are Well Below the Maximum Front-End Sales Loads That Mutual Funds Charge

Percentage of purchase amount, selected years

 Maximum front-end sales load1 Average front-end sales load that
investors actually paid2
EquityHybridBondEquityHybridBond
1990 5.0 5.0 4.6   3.9 3.8 3.8
1995 4.8 4.7 4.1 2.5 2.4 2.4
2000 5.2 5.1 4.2 1.4 1.4 1.4
2005 5.3 5.3 4.0 1.3 1.3 1.3
2010 5.4 5.2 3.9 1.0 1.0 1.0
2015 5.4 5.2 3.8 1.1 1.0 1.0
2016 5.4 5.2 3.7 1.1 1.0 1.0

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1 The maximum front-end sales load is a simple average of the highest front-end load that funds may charge as set forth in their prospectuses.
2 The simple average front-end sales load that investors actually paid is the total front-end sales loads that funds collected divided by the total maximum loads that the funds could have collected based on their new sales that year. This ratio is then multiplied by each fund’s maximum sales load. The resulting value is then averaged across all funds.
Note: Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, Morningstar, and Strategic Insight Simfund

Another important element in the changing distribution structure of mutual funds has been a shift toward asset-based fees, which are assessed as a percentage of the assets that the financial professional helps an investor manage. Increasingly, these fees compensate brokers and other financial professionals who sell mutual funds. An investor may pay an asset-based fee indirectly through a fund’s 12b-1 fee, which is included in the fund’s expense ratio, or directly (out of pocket) to the financial professional, in which case it is not included in the fund’s expense ratio.

In part because of the shift toward asset-based fees (either through the fund or out of pocket), the market shares of front-end and back-end load share classes have declined in recent years, while those in no-load share classes have increased substantially. For example, over the past 10 years, front-end and back-end load share classes had $1 trillion in net outflows (Figure 5.11), and gross sales of back-end load share classes have dwindled almost to zero (Figure 5.12). As a result, the market share of front-end and back-end load share classes fell from 27 percent of long-term mutual fund assets at year-end 2007 to 14 percent at year-end 2016 (Figure 5.13).

Figure 5.11

No-Load Institutional Share Classes Garnered Positive Net New Cash Flow in 2016

Billions of dollars, 2007–2016

 2007200820092010201120122013201420152016
All long-term
mutual funds
$224 -$211 $393 $244 $28 $200 $162 $98 -$123 -$199
Load -2 -156 9 -62 -129 -77 -70 -173 -130 -232
    Front-end1 18 -105 2 -56 -100 -67 >-56 -160 -101 -181
    Back-end2 -42 -39 -24 -27 -23 -16 -11 -9 -7 -5
    Level3 25 -13 31 21 -6 6 -2 -4 -22 -46
    Other4 (*) (*) (*) (*) (*) -1 (*) (*) (*) (*)
    Unclassified5 -2 (*) (*) (*) (*) (*) (*) (*) (*) (*)
No-load6 165 -66 322 265 168 299 270 338 76 113
    Retail 59 -96 137 55 -46 16 38 111 7 -39
    Institutional 106 30 185 210 214 283 232 226 69 152
Variable annuities 25 -26 29 8 -21 -26 -51 -65 -67 -79
“R” share classes7 37 37 33 33 10 4 13 -2 -2 -2

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1 Front-end load > 1 percent. Primarily includes Class A shares; includes sales where front-end loads are waived.
2 Front-end load = 0 percent and contingent deferred sales load (CDSL) > 2 percent. Primarily includes Class B shares.
3 Front-end load ≤ 1 percent, CDSL ≤ 2 percent, and 12b-1 fee > 0.25 percent. Primarily includes Class C shares; excludes institutional share classes.
4 This category contains all other load share classes not classified as front-end load, back-end load, or level load.
5 This category contains load share classes with missing load fee data.
6 Front-end load = 0 percent, CDSL = 0 percent, and 12b-1 fee ≤ 0.25 percent.
7 “R” shares include assets in any share class that ICI designates as a “retirement share class.” These share classes are sold predominantly to employer-sponsored retirement plans. However, other share classes—including retail and institutional share classes—also contain investments made through 401(k) plans or IRAs.
(*) = inflow or outflow of less than $500 million
Note: Components may not add to the totals because of rounding. Data exclude mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, and Morningstar


Figure 5.12

Gross Sales of Long-Term Mutual Funds Are Concentrated in No-Load Share Classes

Billions of dollars, 2007–2016

 2007200820092010201120122013201420152016
All long-term
mutual funds
$2,529 $2,418 $2,375 $2,702 $2,861 $2,963 $3,510 $3,609 $3,503 $3,550
Load 650 604 559 566 543 510 599 545 490 430
    Front-end1 514 482 435 445 439 403 474 432 387 355
    Back-end2 23 20 10 7 4 3 3 2 2 1
    Level3 107 97 112 111 98 99 119 109 99 73
    Other4 3 4 2 2 2 4 3 1 2 1
    Unclassified5 2 1 (*) 1 (*) (*) (*) (*) (*) 1
No-load6 1,471 1,414 1,446 1,706 1,897 2,049 2,498 2,689 2,614 2,727
    Retail 907 807 825 935 948 973 1,153 1,226 1,229 1,223
    Institutional 564 607 621 771 949 1,076 1,345 1,463 1,384 1,504
Variable annuities 320 308 270 318 309 295 287 236 248 245
“R” share classes7 87 91 100 112 111 109 126 139 152 148

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1 Front-end load > 1 percent. Primarily includes Class A shares; includes sales where front-end loads are waived.
2 Front-end load = 0 percent and contingent deferred sales load (CDSL) > 2 percent. Primarily includes Class B shares.
3 Front-end load ≤ 1 percent, CDSL ≤ 2 percent, and 12b-1 fee > 0.25 percent. Primarily includes Class C shares; excludes institutional share classes.
4 This category contains all other load share classes not classified as front-end load, back-end load, or level load.
5 This category contains load share classes with missing load fee data.
6 Front-end load = 0 percent, CDSL = 0 percent, and 12b-1 fee ≤ 0.25 percent.
7 “R” shares include assets in any share class that ICI designates as a “retirement share class.” These share classes are sold predominantly to employer-sponsored retirement plans. However, other share classes—including retail and institutional share classes—also contain investments made through 401(k) plans or IRAs.
(*) = gross sales of less than $500 million
Note: Components may not add to the totals because of rounding. Data exclude mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, and Morningstar


Figure 5.13

Total Net Assets of Long-Term Mutual Funds Are Concentrated in No-Load Share Classes

Billions of dollars, 2007–2016

 2007200820092010201120122013201420152016
All long-term
mutual funds
$8,914 $5,788 $7,797 $9,030 $8,942 $10,361 $12,331 $13,149 $12,896 $13,616
Load 2,795 1,722 2,185 2,352 2,176 2,362 2,652 2,615 2,440 2,371
    Front-end1 2,190 1,374 1,750 1,882 1,751 1,893 2,148 2,116 1,989 1,948
    Back-end2 204 102 98 78 50 39 32 24 15 9
    Level3 379 237 328 381 367 417 459 468 429 408
    Other4 10 7 8 8 7 11 10 7 6 6
    Unclassified5 12 2 2 3 1 2 2 1 (*) 1
No-load6 4,587 3,067 4,249 5,090 5,224 6,261 7,598 8,382 8,373 9,093
    Retail 3,091 1,951 2,659 3,068 2,991 3,464 4,142 4,639 4,598 4,886
    Institutional 1,497 1,116 1,589 2,022 2,233 2,798 3,456 3,743 3,775 4,207
Variable annuities 1,346 854 1,130 1,291 1,251 1,398 1,629 1,671 1,596 1,637
“R” share classes7 187 146 233 297 290 340 452 480 487 514

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1 Front-end load > 1 percent. Primarily includes Class A shares; includes sales where front-end loads are waived.
2 Front-end load = 0 percent and contingent deferred sales load (CDSL) > 2 percent. Primarily includes Class B shares.
3 Front-end load ≤ 1 percent, CDSL ≤ 2 percent, and 12b-1 fee > 0.25 percent. Primarily includes Class C shares; excludes institutional share classes.
4 This category contains all other load share classes not classified as front-end load, back-end load, or level load.
5 This category contains load share classes with missing load fee data.
6 Front-end load = 0 percent, CDSL = 0 percent, and 12b-1 fee ≤ 0.25 percent.
7 “R” shares include assets in any share class that ICI designates as a “retirement share class.” These share classes are sold predominantly to employer-sponsored retirement plans. However, other share classes—including retail and institutional share classes—also contain investments made through 401(k) plans or IRAs.
(*) = total net assets of less than $500 million
Note: Components may not add to the totals because of rounding. Data exclude mutual funds that invest primarily in other mutual funds.
Sources: Investment Company Institute, Lipper, and Morningstar

By contrast, no-load share classes have seen net inflows and rising assets over the past 10 years. No-load share classes—those with neither a front-end nor a back-end load fee and a 12b-1 fee of no more than 0.25 percent—have accumulated the bulk of the net inflows to long-term mutual funds over this period (Figure 5.11). At year-end 2007, no-load share classes accounted for 51 percent of long-term mutual fund assets, rising to 67 percent by year-end 2016 (Figure 5.13).

Some of the shift toward no-load share classes can be attributed to do-it-yourself investors. A larger factor, however, is the growth of sales through DC plans as well as sales of no-load share classes through sales channels that compensate financial professionals (for example, discount brokers, fee-based advisers, full-service brokerage platforms) with asset-based fees outside of funds.

Services and Expenses in 401(k) Plans

Over the past two and a half decades, mutual funds have become the primary vehicle for 401(k) plan investments, with the share of employer-sponsored 401(k) plan assets held by mutual funds rising from 9 percent at year-end 1990 to 63 percent at year-end 2016.

Two competing economic pressures confront employers: the need to attract and retain quality workers with competitive compensation packages and the need to keep their products and services competitively priced. In deciding whether to offer 401(k) plans to their workers, employers must decide if the benefits of offering a plan (in attracting and retaining quality workers) outweigh the costs of providing the plan and plan services. These costs are both the contributions the employer may make to an employee’s 401(k) account and the costs associated with setting up and administering the 401(k) plan on an ongoing basis.

To provide and maintain 401(k) plans, regulations require employers to obtain a variety of administrative, participant-focused, regulatory, and compliance services. Employers offering 401(k) plans typically hire service providers to operate these plans, and these providers charge fees for their services.

As with any employee benefit, the employer generally determines how the costs of providing the benefit will be shared between the employer and employee. 401(k) plan fees can be paid directly by the plan sponsor (the employer), directly by the plan participant (the employee), indirectly by the participant through fees or other reductions in returns paid to the investment provider, or by some combination of these methods (Figure 5.14).

Figure 5.14

A Variety of Arrangements May Be Used to Compensate 401(k) Service Providers

 

Figure 5.14

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Note: In selecting the service provider(s) and deciding the cost sharing for the 401(k) plan, the employer/plan sponsor will determine which combinations of these fee arrangements will be used in the plan.
Source: ICI Research Perspective, “The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2015”

One key driver of 401(k) plan fees is plan size. A Deloitte/ICI study of 361 DC plans in 2013 created and analyzed a comprehensive plan fee measure, the “all-in fee.” The study found that plans with more participants and larger average account balances tended to have lower all-in fees than plans with fewer participants and smaller average account balances. This observed effect likely results in part from fixed costs required to start up and run the plan, much of which are driven by legal and regulatory requirements. It appears that economies of scale are gained as a plan grows because these fixed costs can be spread across more participants, a larger asset base, or both. Plans with a higher percentage of their assets in equity investments tended to have higher all-in fees, reflecting the higher expense ratios associated with equity investing compared with fixed-income investing. The study also examined types of service providers, automatic enrollment, the number of investment options, and variables relating to plans’ relationships with their service providers—but found little impact on fees. In addition, a BrightScope/ICI study of 2014 data for nearly 29,000 large 401(k) plans also found that plans with more assets had lower total plan cost than those with less assets.

Sixty-three percent of 401(k) assets at year-end 2016 were invested in mutual funds, mainly equity mutual funds (59 percent of 401(k) mutual fund assets or 37 percent of all 401(k) plan assets). 401(k) plan participants investing in mutual funds tend to invest in lower-cost funds and funds with below-average portfolio turnover. For example, at year-end 2015, 45 percent of 401(k) equity mutual fund assets were in funds that had average expense ratios of less than 0.50 percent, and another 43 percent had expense ratios between 0.50 and 1.00 percent (Figure 5.15). Also, in 2015, the simple average expense ratio for equity mutual funds offered in the United States was 1.30 percent (Figure 5.3). Taking into account, however, both the funds offered in 401(k) plans and the distribution of assets in those funds, 401(k) plan participants who invested in equity mutual funds paid less than half that amount, 0.53 percent on average, which is also less than the asset-weighted average expense ratio of 0.67 percent for equity mutual funds industrywide. Similarly, equity mutual funds held in 401(k) accounts tend to have lower portfolio turnover in their portfolios. The asset-weighted average turnover rate of equity funds held in 401(k) accounts was 32 percent in 2015, less than the industrywide asset-weighted average of 44 percent.

Figure 5.15

401(k) Equity Mutual Fund Assets Are Concentrated in Lower-Cost Funds

Percentage of 401(k) equity mutual fund assets, 2015

Figure 5.15

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* The total expense ratio includes fund operating expenses and any 12b-1 fees.
Note: Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. Components do not add to 100 percent because of rounding.
Sources: Investment Company Institute and Lipper. See ICI Research Perspective, “The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2015.”

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