Mutual Fund Expense Ratio Trends June 2014

Transcription

1 Mutual Fund Trends June 2014 Russel Kinnel Director of Manager Research Fund fees dropped in 201 courtesy of the huge stock market rally that year. Market rallies cause the total assets under management of the fund industry to grow tremendously and that in turn triggers breakpoints in mutual fund management fees. Those breakpoints are built into a fund s fee structure so a fund charges less for each additional dollar managed over various AUM thresholds. The industry also shares some other efficiencies from the greater economies of scale, though they of course keep quite a bit to themselves. The average investor in open-end mutual funds paid 0.71% in expenses in 201 versus 0.72% in 2012 and 0.78% in The figure has gradually come down from a peak of 0.95% in We calculate a figure for the average investor by asset-weighting expense ratios so that big funds count more than small ones. We include all open-end funds except for funds of funds. If we look at the average mutual fund instead of the average investor, the trend is the same but at higher cost. Today the average fund charges 1.25%, down from 1.28% in 2012 and off from a peak of 1.47% in 200. You can see the long-term trends in this graph. As assets in mutual funds have grown, expense ratios have steadily come down. We graphed the average and asset-weighted averages for all funds and for U.S. stock funds. The asset-weighted average tells you what the typical investor paid. Fund Fees Declining Over the s p U.S. Equity p All Funds 1.2 p U.S. Equity Asset-Weight p All Funds Asset-Weight Source: Morningstar, Inc. Data from

2 Page 2 of 18 Mutual Fund Trends June 2014 If we break the data down by fund group, we see that most of the decline was in equities. The typical investor in U.S. stock funds paid 0.67% in 201, down from 0.70% in The average investor in foreign equities paid 0.78% versus 0.80%. The typical sector fund investor paid 0.90% versus 0.92%. In 201, balanced funds dropped 2 basis points to 0.78% for the average investor. I was a little surprised to see bond-fund expenses drop, as most bond categories were flat for the year. Even so, the typical investor in a bond fund paid 1 basis point less, down to 0.60% in 201. Municipal bonds remained flat at 0.59% for the average investor. The good news is that expenses will likely come down more for fiscal 2014 barring a huge market swoon in the second half. The reason is that 201 s rally continued toward the end of the year so that the growth in assets wasn t fully captured by 201 s figures, which reflect the 12 months ended October 201. What s Driving Lower Fees? Asset growth is by far the biggest driver, as funds typically have breakpoints set to automatically lower fees as assets grow. And the largest part of asset growth will usually be market performance, as in 201. However, a second component is fund flows. Fund investors have become smarter about buying cheaper funds. Last year, 95% of net inflows went into funds with expense ratios that ranked in the cheapest quintile of their category peers. The two years prior it was actually greater than 100% because you had money going out of pricier funds even as it was rushing into cheaper funds. Investors were less choosy about fees. On average only 56% of net inflows went into the cheapest quintile in the 90s. Low costs generally lead to superior returns, so no doubt some of the money going into low-cost funds also reflects investors following performance as well as expenses. A big component of that move to lower costs is passive investments. But it doesn t stop there. Money has flowed into lower-cost institutional bond funds that are actively managed, too. And even within actively managed equity funds, quite a bit of the money flowing in ends up in lower-cost funds. redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

3 Page of 18 Mutual Fund Trends June 2014 The Predictive Power of s I looked back at the predictive power of expense ratios to see how they fared at inflection points even as past performance was less helpful. I grouped funds by asset class and then expense ratio as of June 2008, June 2009, and June The Success Rate The success rate tells you what percentage of funds survived and outperformed over the ensuing period. It s important to take into account funds that are liquidated because high-cost funds are more likely to be killed off than low-cost funds. Thus, failures from high-cost groups are wiped away. If you don t account for those failures, your study is survivorship-biased. Thus, I like the success rate for its ability to be bias-free. It s also important to use available data at the time to test the realworld results. Simply taking a data point published in 2014 and looking backward at returns doesn t really lead to useful information. The expense ratio is a nearly complete, all-in measure of the percentage of assets fundholders are paying in fees. It includes money for the managers, analysts, traders, transfer agents, compliance officers, customer service reps, lawyers, directors, technology providers, research resources, and printers, plus additional profits for the fund company, brokerage, and possibly the broker or financial planner. I broke each category down to five quintiles based on expense ratios. The expenses are deducted in small amounts every business day, and a fund s net asset value is thus adjusted accordingly to account for these fees. in 2008 The expense ratio would have helped you make better decisions in all asset classes in Spoiler alert: It did the same in 2009 and Let s look at the details. In 2008, the cheapest quintile in U.S.-equity funds produced a success rate of 56% compared with 4% for the priciest quintile. That means your chances for success in a cheap fund were twice as great as in a pricey one. For foreign stocks, it was 60% versus 28%. For balanced, it was 65% versus 29%. For taxable bond, it was 65% versus 2%, and it was 67% versus 15% for munis. So, every asset class showed strong predictive power for expense ratios. The cheapest quintile outperformed the second cheapest in every case, too, although less dramatically. in 2009 and 2010 The pattern continued in 2009 and s were a powerful predictor over different asset classes and time periods even though the markets swung dramatically into a rally. Past perfor- redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

4 Page 4 of 18 Mutual Fund Trends June 2014 mance was not a lot of help as superconservative funds looked best in early 2009 just as it was time for aggressive funds to run. The cheapest quintile had a 59% success rate while it was 25% for the priciest. What if It s Just a Share-Class Thing? When you include all share classes in a test, you will have many share classes of the same fund, so naturally you d expect PIMCO s Institutional shares to beat its A shares. But what if you just used one share class per fund? Would that diminish the predictive power of fees? The answer is yes, but it s still quite powerful. In every test we still saw the cheapest quintile trounce the priciest. Back to domestic stocks in June 2008, the cheapest quintile s success rate fell a hair to 55% from 56% and the priciest quintile bounced up from 24% to 0% success rate. So you still nearly doubled your chances of success by choosing low cost funds. In foreign equities in 2008, the cheapest quintile success rate was 57% versus 7% for the priciest quintile. For balanced funds, the cheapest quintile had a 50% success rate versus 27%. For taxable bond it was 50% versus 5% and for munis it was 65% versus 2%. For June 2009, we saw the success of the cheapest quintile rise a bit with our oldest share class test as it rose from 59% to 61% but the priciest quintile s success rate also rose to 28%. For foreign equities, however, it shrunk to a 46% to 40% gap. For balanced, it was 56% versus 4%. For taxable bonds it was 47% versus 7%. For munis we saw a 41% success rate versus 26% for the priciest quintile. Why s Worked So Consistently Fees matter in bull markets and bear markets. In growth and value markets, fees still matter. A performance measure can accidentally capture a lot of the noise in markets as one area moves in and out of favor and as caution reigns, then aggression. But expenses are just so dependable that it makes sense to make them an initial screen in your process. To quote from the book of Bogle: You get what you don t pay for. Vanguard founder Jack Bogle has pointed out that markets don t have to be efficient for low costs to work. We know that mutual funds as a whole will get roughly the market s return minus fees and trading costs. Those that charge less are naturally more likely to outperform than those with high costs. redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

5 Page 5 of 18 Mutual Fund Trends June 2014 Table 1 Trends US Equity Sector Equity Balanced International Equity funds funds funds Source: Morningstar, Inc. Data as of 12/1/201. Open-end funds excluding funds of funds. funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

6 Page 6 of 18 Mutual Fund Trends June 2014 Table 1 (continued) Trends Alternative Taxable Bonds Municipal Bonds All Funds funds funds funds Source: Morningstar, Inc. Data as of 12/1/201. funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

7 Page 7 of 18 Mutual Fund Trends June 2014 Table 2 Flow Trends in U.S. Stock Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,917,287,102 2,77,65, ,744,885, ,84,60,806 8,092,77, ,12,21, ,71,455,07 12,717,040, ,575,6, ,124,161,647 14,12,06, ,091,77, ,540,178,117 1,166,590, ,917,555, ,696,00,84 29,855,267, ,67,815, ,841,807,80 5,21,085, ,14,014,29, ,629,697,07 57,84,248, ,559,968,465, ,708,175,756 50,79,900, ,987,699,002, ,469,548,968 80,247,850, ,64,944,576, ,756,69,491 61,650,61, ,57,07,28, ,27,709,110 9,102,996, ,267,80,472, ,26,601,97 -,247,95, ,810,94,2, ,179,52,442 72,476,299, ,482,890,940, ,826,72,967 66,518,292, ,891,998,741, ,96,766,727 17,51,548, ,095,848,87, ,522,689,156 21,702,646, ,529,559,908, ,582,450,451 24,649,046, ,722,184,054, ,776,907,480-7,85,215, ,185,755,297, ,6,079,174 6,844,540, ,8,14,788, ,957,08,707 7,147,265, ,22,54,017, ,4,917,982-6,246,551, ,074,120,110, ,756,046,474-0,250,709, ,444,707,271, ,6,824,0 50,978,91, ,70,582,095, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

8 Page 8 of 18 Mutual Fund Trends June 2014 Table Flow Trends in Sector Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,145,050 1,56,446, ,51,878,882 9,880, ,855,766, ,20,812,146 1,558,276, ,49,515, ,08,798,942 2,229,448, ,254,285, ,65,986,548-65,976, ,418,944, ,771,87,821 1,05,154, ,98,021, ,485,111,055 1,840,228, ,99,009, ,409,017,091,901,755, ,100,167, ,66,299,967 1,16,49, ,006,810, ,755,200,714 14,27,797, ,162,65, ,872,88,867 29,66,064, ,98,510, ,516,50,065-5,426,149, ,546,00, ,210,62,647-2,687,161, ,29,4, ,227,001,566,424,816, ,270,151, ,791,727,027 4,449,178, ,060,686, ,074,017,622 6,211,241, ,559,090, ,576,80,12 529,75, ,47,597, ,50,247,50-4,282,850, ,804,005, ,081,706,522-91,894, ,8,745, ,109,078,407 2,14,60, ,44,42, ,171,291,18,405,850, ,089,756, ,922,60,128 4,075,02, ,171,24, ,807,422,591,120,771, ,57,084, ,278,20,95 14,,296, ,05,92, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

9 Page 9 of 18 Mutual Fund Trends June 2014 Table 4 Flow Trends in Balanced Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,12,152 1,117,521, ,555,29, ,842,90,545,00,772, ,5,95, ,06,661,91 8,142,00, ,584,692, ,715,828,468 15,609,449, ,40,621, ,007,071,07 7,21,26, ,515,082, ,95,242,748,786,214, ,209,828, ,058,028,257 4,229,099, ,72,96, ,208,95,908,55,2, ,480,89, ,90,154,500 4,812,497, ,295,81, ,447,024,898-7,5,85, ,600,604, ,021,21,47-18,012,794, ,114,101, ,960,44,902 2,65,491, ,410,6, ,80,894,25 9,85,906, ,1,194, ,157,045,578 24,05,909, ,170,924, ,27,18,715 29,965,667, ,169,827, ,919,475,281 2,815,488, ,754,562, ,5,885,476 11,642,176, ,094,709, ,788,961,98 21,552,758, ,194,657, ,79,074,89-9,120,827, ,62,145, ,688,146 74,291, ,704,857, ,522,751,64 6,44,246, ,557,24, ,208,419,411-1,019,218, ,082,46, ,111,65,659 7,887,44, ,281,695, ,261,186,445 12,009,26, ,054,552,625, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

10 Page 10 of 18 Mutual Fund Trends June 2014 Table 5 Flow Trends in International-Equity Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,060,172 08,22, ,720,67, ,69,862,18 1,009,90, ,492,14, ,071,208,299 2,097,982, ,858,06, ,025,291,765 10,905,50, ,092,069, ,259,916,562 15,920,662, ,864,254, ,11,06,612 8,961,075, ,905,111, ,98,79,797 22,729,664, ,867,976, ,899,529,647 2,064,24, ,574,402, ,024,744,40,864,711, ,647,579, ,769,921,755 7,005,54, ,117,514, ,69,151,088 16,677,758, ,142,72, ,997,206,69-12,78,416, ,074,05, ,205,674-2,250,77, ,486,122, ,289,22,741 1,56,01, ,102,81, ,618,56,108 4,91,680, ,485,206, ,460,677,116 56,872,60, ,98,041, ,719,060,047 87,018,65, ,27,5,767, ,611,619,77 91,451,457, ,560,249,884, ,910,717,426-7,94,415, ,465,874, ,11,469,756 14,960,791, ,14,55,709, ,572,644,107 42,576,09, ,24,1,14, ,806,665,09 8,26,291, ,16,487,924, ,55,790,444,785,41, ,9,22,90, ,497,584,605 87,808,278, ,79,755,914, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

11 Page 11 of 18 Mutual Fund Trends June 2014 Table 6 Flow Trends in Alternative Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,629, , ,487,97, ,696,967-47,20, ,508,447, ,228,569 54,588, ,075,299, ,60,04-18,9, ,152,47, ,76,61-84,17, ,124,412, ,547,71-47,466, ,11,017, ,712,949 68,675, ,179,17, ,798, ,494, ,709,099, ,206, ,10, ,144,70, ,884,217 10,46, ,947,6, ,489, ,117, ,650,172, ,779,457 1,571, ,86,927, ,667,569,85 1,15,745, ,177,909, ,784,80,98 2,06,965, ,61,277, ,421,12,082,178,549, ,492,869, ,926,79,706 1,548,04, ,052,177, ,440,917,444,554,114, ,584,875, ,54,17,1 749,96, ,712,52, ,105,700,516 1,214,580, ,018,942, ,278,156,842 4,684,884, ,62,298, ,406,128,80 10,72,984, ,60,084, ,906,615,64 2,979,960, ,54,727, ,17,46,44 7,994,691, ,080,428, ,817,869,22 10,254,55, ,728,846, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

12 Page 12 of 18 Mutual Fund Trends June 2014 Table 7 Flow Trends in Taxable-Bond Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,479,029 14,451, ,588,449, ,72,127,95 1,454,55, ,075,265, ,90,784,180 10,076,540, ,169,129, ,650,174,570 10,568,666, ,5,195, ,68,57,967-12,614,20, ,680,126, ,061,82,10 5,709,274, ,020,029, ,95,159,257 8,717,450, ,85,000, ,822,277,846 1,047,58, ,001,418, ,499,508,602 2,978,996, ,45,277, ,525,902 12,904,4, ,058,177, ,071,015,546-6,011,408, ,746,207, ,1,09,785 16,111,146, ,207,075, ,441,958,20 47,504,44, ,410,998, ,180,09,18 22,068,862, ,14,629, ,146,660,408 16,985,021, ,147,70, ,106,00,209 19,492,858, ,90,25, ,584,998, 2,045,881, ,257,082, ,495,82,515 60,75,419, ,120,495,557, ,191,819,499 17,685,844, ,056,409,09, ,729,60, ,080,218, ,50,801,72, ,52,045, ,29,595, ,826,195,92, ,818,72,420 95,852,955, ,046,986,174, ,124,04,94 186,642,804, ,488,824,701, ,862,277,016 17,718,140, ,485,615,16, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

13 Page 1 of 18 Mutual Fund Trends June 2014 Table 8 Flow Trends in Municipal-Bond Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,84, ,804,702, ,17,455,197 5,254,120, ,245,28, ,265,00,726 6,468,811, ,15,61, ,429,818,451 7,487,820, ,229,864, ,850,602,91-6,420,454, ,908,024, ,517,18,189-97,111, ,242,16, ,0,017,921-1,590,409, ,95,049, ,177,58, ,987, ,540,941, ,6,85,184 9,818,568, ,910,006, ,677,95,7 -,857,894, ,64,78, ,659,998,564-6,079,121, ,557,545, ,780,618,291-1,006,062, ,486,16, ,11,897,440 6,66,26, ,819,0, ,66,265,954-4,0,057, ,149,827, ,070,758,69-7,66,49, ,708,274, ,592,6,770 2,091,998, ,281,714, ,66,170,779 8,986,228, ,164,219, ,21,770,048 9,880,00, ,574,29, ,901,084,21 6,560,001, ,969,690, ,227,221,91 6,48,686, ,542,587, ,547,60,691 6,169,67, ,808,59, ,292,692,294 1,868,926, ,252,678, ,629,090,110 24,919,056, ,241,722, ,659,647,041-12,849,18, ,959,46, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

14 Page 14 of 18 Mutual Fund Trends June 2014 Table 9 Flow Trends in All Funds by Fees Annual Flows Annual Flows in Cheapest % Annual Flow in Cheapest Total Assets ,446,787,895 4,42,41, ,464,488, ,66,14,041 1,401,450, ,66,290, ,021,994,002 41,115,540, ,747,910, ,899,44,800 60,914,558, ,84,586,211, ,958,568,267 16,92,680, ,412,428,401, ,48,899,515 49,220,408, ,850,129,140, ,7,540,774 89,225,79, ,284,512,465, ,12,884, ,642,411, ,89,465,69, ,145,799,924 94,492,478, ,529,209,989, ,825,756,526 10,494,500, ,408,60,275, ,450,577,894 77,420,020, ,258,781,14, ,42,716,476 9,071,874, ,927,90,516, ,58,520,52 56,867,009, ,596,941,186, ,575,219,208 1,922,99, ,700,842,792, ,001,20, ,948,890, ,45,251,249, ,977,618,10 10,292,800, ,029,402,285, ,681,609, ,922,808, ,11,286,956, ,17,511,715 20,620,592, ,875,18,195, ,116,965,09 451,870, ,129,015,95, ,28,094,64 222,449,019, ,879,2,08, ,255,001, ,995,040, ,975,149,524, ,126,12, ,175,29, ,91,158,52, ,94,442,76 25,665,458, ,208,499,264, ,921,05, ,50,212, ,067,478,747, Source: Morningstar, Inc. Data as of 12/1/201. Funds redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

15 Page 15 of 18 Mutual Fund Trends June 2014 Table 10 Predictive Power of Fees June 2008 June 201 Broad Group Begin Yr Total Return Tot Return % Rank Tot Return Batting Tot Return Success Rate Standard Deviation Avg Rate of 5-Yr Investor Return as of 06/0/201 5-Yr Investor Rank as of 06/0/201 5-Yr Investor Return Batting Avg 5-Yr Investor Return Success Rate -Yr Rating as of June 0, End 5-Yr Rating as of 06/0/201 End For -Yr Rating US Equity Sector Equity Int l Equity Balanced Taxable Bond Muni Bond Source: Morningstar, Inc. Data as of 07/01/201. redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

16 Page 16 of 18 Mutual Fund Trends June 2014 Table 11 Predictive Power of Fees June 2009 June 201 Broad Group Begin Yr Total Return Tot Return % Rank Tot Return Batting Tot Return Success Rate Avg Standard Rate of Deviation -Yr Rating as of June 0, End End For -Yr Rating US Equity Sector Equity Int l Equity Balanced Taxable Bond Muni Bond Source: Morningstar, Inc. Data as of 07/01/ redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

17 Page 17 of 18 Mutual Fund Trends June 2014 Table 12 Predictive Power Single Share Class (2008) 5-Yr Time Period Broad Group Begin Yr Total Return Tot Return % Rank Tot Return Batting Total Return Success Rate Standard Deviation Standard Deviation Batting Avg Standard Deviation Success Rate of 5-Yr Investor Return as of 06/0/201 5-Yr Investor Return Success Rate -Yr Rating as of June 0, End 5-Yr Rating as of 06/0/201 US Equity Sector Equity Int l Equity Balanced Taxable Bond Muni Bond Source: Morningstar, Inc. Data as of 07/01/ redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted

18 Page 18 of 18 Mutual Fund Trends June 2014 Table 1 Predictive Power Single Share Class (2009) 4-Yr Time Period Broad Group Begin Yr Total Return Tot Return % Rank Total Return Success Standard Deviation Standard Deviation Batting Standard Deviation Success of -Yr Rating As of June 0th, End US Equity Sector Equity Int l Equity Balanced Taxable Bond Muni Bond Source: Morningstar, Inc. Data as of 07/01/ redistributed, () do not constitute investment advice offered by Morningstar (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted