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Letter from the ICI Research: Chapter 1: Chapter 2: Chapter 3: Chapter 5: Chapter 6: Chapter 7: |
Trends in Mutual Fund Fees and ExpensesTo understand trends in mutual fund fees and expenses, it is helpful to combine major fund fees and expenses into a single measure. ICI created such a measure by adding a fund’s annual expense ratio to an estimate of the annualized cost that investors pay for one-time sales loads. This measure is reported as an asset-weighted average, which gives more weight to those funds that have the most assets. Mutual fund fees and expenses that investors pay have trended downward since 1990. In 1990, investors in stock funds, on average, paid fees and expenses of 2.00 percent of fund assets. By 2010, that figure had fallen by more than 50 percent to 0.95 percent (Figure 5.1). Fees and expenses paid on bond funds declined by 61 percent from 1.85 percent of fund assets to 0.72 percent over the same time period. Fees and Expenses Incurred by Stock and Bond Mutual Fund Investors Have Declined by More Than Half Since 1990 Percent, selected years
Download an Excel file of this data. 1Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. Figure reports year-end asset-weighted average of annual expense ratios and annualized loads for individual funds.
There are a number of reasons for the dramatic drop in fees and expenses incurred by mutual fund investors. First, investors generally pay much less in sales loads than they did in 1990. Maximum front-end loads that an investor might pay for investing in mutual funds have remained fairly stable since 1990 (Figure 5.2). However, the front-end loads that shareholders actually incurred—sometimes referred to as the effective load—have fallen significantly. For stock funds, for example, the average front-end sales load actually paid fell from 3.9 percent in 1990 to 1.0 percent in 2010. A key factor contributing to the steep decline in loads paid has been the growth of mutual fund sales through employer-sponsored retirement plans. Load funds often waive loads for purchases of fund shares through such retirement plans. Front-End Sales Loads That Investors Pay Were Well Below Maximum Front-End Sales Loads Percentage of purchase amount, selected years
Download an Excel file of this data. 1The maximum front-end sales load is a simple average of the highest front-end sales load that funds may charge as set forth in their prospectuses. The average actually incurred is the maximum sales load multiplied by the ratio of total front-end sales loads collected by stock funds as a percentage of new sales of shares by such funds.
Another reason for the decline in the fees and expenses of investing in mutual funds has been growth in the sales of no-load funds. Much of the increase in sales of no-load funds has occurred through the employer-sponsored retirement plan market. In addition, sales of no-load funds have also expanded through mutual fund supermarkets, discount brokers, and full-service brokerage platforms that compensate financial advisers with asset-based fees paid outside of funds. Finally, mutual fund fees have been pushed down by economies of scale and competition within the mutual fund industry. The demand for mutual fund services has increased dramatically over the past several decades. For example, the number of households owning mutual funds has more than doubled since 1990, going from 23.4 million in 1990 to 51.6 million in 2010. Over the same period, the number of shareholder accounts rose from 61.9 million to over 290 million. Ordinarily, such a sharp increase in demand could tend to raise fund expense ratios. Any such effect, however, was more than offset by the downward pressure on fund expense ratios from competition among existing fund sponsors, the entry of new fund sponsors into the industry, economies of scale resulting from the growth in fund assets, and shareholder movement to lower-cost funds. Shareholder Demand for Lower-Cost FundsICI research indicates that mutual fund shareholders invest predominantly in lower expense ratio funds. This can be seen by comparing the average expense ratio on mutual funds offered in the marketplace with the average expense ratio actually paid by mutual fund shareholders (Figure 5.3). The simple average expense ratio of stock funds (which measures the average expense ratio of all stock funds offered in the market) was 1.45 percent in 2010. The average expense ratio that stock fund shareholders actually paid (the asset-weighted average expense ratio across all stock funds) was considerably lower: just 0.84 percent of stock fund assets. Fund Shareholders Paid Lower-Than-Average Expenses in Stock Funds1, 2 Percent, 1996–2010
Download an Excel file of this data. 1Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
Another way to illustrate that investors demand mutual funds with lower expense ratios is to identify how investors allocate their new purchases of mutual fund shares. During the 11-year period 2000 to 2010, stock funds with expense ratios in the lowest quartile received 82 percent of all net new cash flow, while the remaining 75 percent of funds received only 18 percent of the net new cash (Figure 5.4). This pattern holds for actively managed stock funds, stock index funds, and target date funds (funds that adjust their portfolios, typically more toward fixed income, as the fund approaches and passes the fund’s “target date”). Stock index funds with expense ratios in the lowest quartile garnered 86 percent of the net new cash flow over the 11 years. Since 2005, target date funds with expense ratios in the lowest quartile have received 83 percent of the new net cash to such funds. Least Costly Stock Funds Attract Most of the Net New Cash Percent, 2000–2010
Download an Excel file of this data. 1Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. Factors Influencing Mutual Fund ExpensesThe prices of most goods and services differ considerably across the array of available products. Mutual funds are no exception: expense ratios vary across the range of mutual funds (Figure 5.5). The level of fund expenses depends on the fund investment objective, fund assets, balances in shareholder accounts, payments to intermediaries, and other factors. Expense Ratios for Selected Investment Objectives* Percent, 2010
Download an Excel file of this data. *Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. Fund Investment ObjectiveExpenses vary by type of fund; for example, bond and money market funds tend to have lower expense ratios than equity funds. Among equity funds, expense ratios tend to be higher among funds that specialize in particular sectors—“sector” funds, such as healthcare or real estate—or those that invest in international stocks, because such funds tend to be more costly to manage. Even within a particular type of investment objective, there can be considerable variation in fund expense ratios. For example, 10 percent of aggressive growth equity funds have expense ratios of 0.89 percent or less, while 10 percent have expense ratios of 2.27 percent or more. Among other things, such variation reflects the fact that some aggressive growth funds focus more on small- or mid-cap stocks while others focus more on large-cap stocks. This can be significant because portfolios of small- and mid-cap stocks tend to be more costly to manage. Fund and Average Fund Account SizeOther factors—such as fund size and average fund account size—also help explain differences in fund expense ratios. These two factors vary widely across the industry. In 2010, the median long-term mutual fund had assets of $264 million (Figure 5.6). Twenty-five percent of all long-term funds had assets of $70 million or less, while another 25 percent of long-term funds had assets greater than $929 million. Average fund account balances show similar variation. In 2010, 50 percent of long-term funds had average account balances of $49,052 or less. Twenty-five percent of long-term funds had average account balances of $19,307 or less. At the other extreme, 25 percent of long-term funds had average account balances of more than $162,094. Fund Sizes and Average Account Balances Varied Widely Long-term funds, year-end 20101, 2
Download an Excel file of this data. 1Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
All else equal, larger mutual funds tend to have lower-than-average expense ratios because of economies of scale. Funds with higher account balances also tend to have lower expense ratios than other funds. This reflects the fact that each account, regardless of its size, requires certain services (such as mailing periodic account statements to account holders). Funds that cater primarily to institutional investors—who typically invest large amounts of money—tend to have higher average account balances. Funds that primarily serve retail investors typically have lower average account balances.
Because larger funds typically have lower expense ratios, the expense ratios of individual funds often fall as those funds grow. This is illustrated in Figure 5.9, which tracks the expense ratios of domestic equity funds continuously in existence since 1991, along with the growth in their assets. Generally, the expense ratios of these funds declined as their total net assets rose, and vice versa. For example, from 1991 to 2010, the average expense ratio of this group of funds fell 13 percent, reflecting trend growth in their assets. On the other hand, when the assets of these funds declined during the bear markets that began in 2000 and 2007, their average expense ratio rose. Payments to IntermediariesAnother factor that helps explain variation in fund fees is whether funds are sold through intermediaries, such as brokers or registered financial advisers. These professionals help investors define their investment goals, select appropriate funds, and provide ongoing advice and service. Financial advisers can be compensated for these services through a particular kind of fund fee, known as a 12b-1 fee, which is included in a fund’s expense ratio. As a result, funds sold through intermediaries tend to have higher expense ratios than other funds (no-load funds). No-load funds are sold directly to investors or are sold to investors through financial advisers who charge investors separately for investment advice. Thus, no-load funds tend to have lower expense ratios than other funds with similar investment objectives. Fund Expense Ratios Tend to Fall as Fund Total Net Assets Rise Share classes of domestic equity funds continuously in existence since 19911
Download an Excel file of this data. 1Calculations are based on a fixed sample of share classes. Sample includes all domestic equity share classes continuously in existence since 1991, excluding mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. The Changing Distribution Structure of Mutual FundsMany mutual fund investors pay for the services of a professional financial adviser. ICI research finds that among investors owning mutual fund shares outside of retirement plans at work, 81 percent own fund shares through professional financial advisers. Financial advisers typically devote time and attention to prospective investors before investors make an initial purchase of funds and other securities. The adviser generally meets with the investor, identifies financial goals, analyzes existing financial portfolios, determines an appropriate asset allocation, and recommends funds to help achieve the investor’s goals. Advisers also provide ongoing services, such as periodically reviewing investors’ portfolios, adjusting asset allocations, and responding to customer inquiries. Thirty years ago, fund shareholders usually compensated financial advisers for their assistance through a front-end load—a one-time, upfront payment for current and future services. After 1980, when the U.S. Securities and Exchange Commission (SEC) adopted Rule 12b-1 under the Investment Company Act of 1940, funds and their shareholders had greater flexibility in compensating financial advisers. Rule 12b-1 and subsequent regulatory action established a framework under which investors can pay indirectly for some or all of the services they receive from financial advisers through 12b-1 fees—asset-based fees that are included in a fund’s expense ratio. Under this framework, 12b-1 fees can also be used to compensate financial intermediaries, such as retirement plan recordkeepers and discount brokerage firms, for the services they provide to fund shareholders. Although they can be used to pay for advertising and marketing, 12b-1 fees are primarily used to compensate financial advisers and other financial intermediaries for assisting fund investors before (40 percent of fees collected) and after they purchase fund shares (52 percent of fees collected) (Figure 5.10). Most 12b-1 Fees Used to Pay for Shareholder Services Percentage of 12b-1 fees collected, 2004
Download an Excel file of this data. Source: ICI Fundamentals, “How Mutual Funds Use 12b-1 Fees”
The introduction of Rule 12b-1 changed the means by which financial advisers were compensated. The maximum front-end load fees that funds might charge declined sharply in the 1980s as funds adopted 12b-1 fees as an alternative way to compensate financial advisers and intermediaries for providing services to fund shareholders. Since 1990, 12b-1 fees paid by shareholders rose from $1.1 billion to $10.6 billion (Figure 5.11). This increase reflects, in part, the roughly tenfold increase in mutual fund assets and the more than twofold increase in the number of households owning funds since 1990. 12b-1 Fees Paid Reflect Asset Growth and Shift in Source of Financial Advisers’ Compensation Billions of dollars, selected years*
Download an Excel file of this data. 1Data exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds.
In recent years, the system for compensating financial intermediaries for distributing mutual fund shares and assisting investors has continued to evolve. For example, maximum front-end load fees have stabilized, but front-end load fee payments (as a percentage of assets) have continued to decline. This, in large measure, reflects the discounts from the maximum front-end load that investors often receive when making large share purchases or purchases through 401(k) plans. There has also been a shift by investors toward no-load share classes. No-load share classes have consistently attracted more net new cash than load share classes in recent years (Figure 5.12). In 2010, for example, no-load share classes of long-term funds garnered $253 billion in net new cash, compared to an outflow of $33 billion for load share classes. Cumulatively, these flows have led to a concentration of long-term fund assets in no-load share classes; by 2010, no-load share classes of long-term funds had $5.1 trillion in total net assets compared to $2.6 trillion in load share classes (Figure 5.13). The shift toward no-load funds should not be taken as indicating that investors are eschewing advice from financial advisers. To be sure, some of the flows to no-load funds owe to “do-it-yourself” investors. However, much of the shift represents a change in the way investors compensate their financial advisers, with many investors now paying for financial advice directly out of their pockets instead of indirectly through their mutual funds. Flows from 401(k) plans and other retirement accounts also are often invested in no-load funds. Net New Cash Flow Was Greatest in No-Load Share Classes Billions of dollars, 2001–2010
Download an Excel file of this data. 1Front-end load > 1 percent. Primarily includes A shares; includes sales where front-end loads are waived. Total Net Assets of Long-Term Funds Were Concentrated in No-Load Share Classes Billions of dollars, 2001–2010
Download an Excel file of this data. 1Front-end load > 1 percent. Primarily includes A shares; includes sales where front-end loads are waived.
For More Information
Available at www.ici.org. |
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