Cheap Passives Dominated 2017

January 19, 2018

ETFs are famously cheap. As of the end of 2017, the average asset-weighted expense ratio for all U.S.-domiciled ETFs was 0.23%. Actively managed mutual funds cost 0.80% on an asset-weighted basis as of the end of 2016, according to the ICI. 

The cost comparison becomes even clearer when broken down by asset class. Equity

ETFs are nearly one-fourth the cost of actively managed mutual funds; bond funds nearly one-third.



Once year-end 2017 ICI data becomes available, we might see mutual fund costs drop a bit, as they have done every year since 2003. Recent annual drops have been between 0.01% and 0.02%. That’s nowhere near enough to achieve cost-competitiveness.

Cheap, Vanilla Funds Won In 2017

Within the ETF world, costs continue to fall, as this year’s revived price wars attest. Last year, ETF investors flocked to low-cost funds and spurned higher-cost funds. Funds that could not compete closed, leaving higher costs in the ETF dustbin. ETF investors are now demanding price tags of 20 basis points or less. In some cases, much less.

Here’s how fee compression worked in the ETF landscape in 2017, by asset class. The table below shows asset-weighted average expense ratios by asset class, using fees and AUM as of December 29, 2017, except for funds that closed during 2017, for which data is as of the end of 2016.



The data above suggest that asset managers who wish to attract share in the ETF marketplace can take one of two paths: Find a segment without competition or prepare to compete hard on price. Right now, the magic number is 15 basis points for fixed income and 17 basis points for equity—that’s 99% of the ETF market, by assets. In some segments, the magic number is lower still.

In 2017, just 26 funds (1%) captured 50% of the inflows. By year-end, the median expense ratio for that elite set was just 7 basis points. 

In the 10 segments that garnered the highest flows, funds that gained market share cost 10 basis points on average, while losers cost 19. These segments hold 65% of all U.S. ETF assets.



Within market segments, ETFs compete on strategy. FactSet recognized four major strategy groups: vanilla, strategic, idiosyncratic and active. Vanilla funds are the simplest, selecting all securities within the opportunity set and weighting them by market cap. Strategic funds, sometimes called smart beta, select and weight securities using academically researched economic criteria. Idiosyncratic funds use noneconomic criteria to build an index. Finally, active funds have humans at the helm.


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