Fees Falling (Or Are They?)

July 27, 2007

The ICI says fees are down. And that glass is one-sixteenth full...

Not too long ago, the Investment Company Institute released a report on the decline of mutual fund expense amounts titled Fees and Expenses of Mutual Funds, 2006. According to the ICI's research, the average fees and expenses of stock and bond mutual funds have fallen by 50% since 1980.

The average for stock funds in 2006 was 107 basis points (1.07%) in fees and expenses, including loads, which was down 4 basis points (0.04%) from the previous year. Meanwhile, the ICI says bond fund expenses fell 0.05% to 0.83% in 2006 and money market fund expenses a smidge (0.02%) as well.

On one level, the top-line 50% decline in fund fees seems extraordinary. It is rare for prices on anything to fall by half. Of course, as pointed out here often, in terms of scale, the more assets a fund has, the cheaper it is to manage, and the assets in mutual funds have increased exponentially over the year. ICI research puts the amount of assets in mutual funds at around $50 billion from the end of the 1960s into the early 1980s, before a period of spectacular growth in the 1990s that drove assets up above $4 trillion. As of the end of 2006, mutual fund assets were at $10.4 trillion. That means assets have grown about 20,000% since 1980!

In that context, a 50% reduction in fees doesn't seem so terribly breathtaking. Moreover, average fees of 1.07% of assets are still obscenely expensive when compared with index funds, where fees run down into the single basis points for various funds.

Part of the decline in overall fees, ICI says, can be attributed to the decline in fund loads, although many funds are load-free. Loads averaged 5.28% for 2006, but the actual amount paid by investors averaged 1.31%, down 4 basis points from the previous year. The reason for this is that many funds waive their loads if the investment is made through a 401(K) or meets a minimum investment threshold. And of course, expense ratios have also been declining-down 2 basis points in just the last year and 11 basis points in the past five years. The decline in 2006 is attributed to more assets flowing to funds with lower expense ratios and to the lowering of expense ratios by funds trying to remain competitive.

Exchange-traded funds (ETFs) are, of course, mutual funds that trade like stocks. They have no loads (although you must pay a commission to buy one), and their expense ratios are generally minimal. For a little perspective on the average fees for mutual funds, consider that the median expense ratio for an ETF in 2006 was just 0.36%. However, as the ETF industry expands into more complex strategies, its expense ratios are increasing as well. The 2006 figure is actually up from a median expense ratio of 0.28% in 2004, and the average expense ratio for funds launched since November 2006 is 0.67%.

The ICI report said that 90% of investors' assets are in funds with below-average expense ratios. Not surprisingly, the highest expense ratio for the top 25 funds as determined by MarketWatch was 1.01%.

The ICI investor assets statistic gets more interesting when it's broken down further: While actively managed funds with below-average expense ratios get 87% of new cash coming into those types of funds, index funds with below-average expense ratios get 98% of new cash. Looks like index investors might be just a bit more savvy than active investors.

Overall, the ICI says that 2006 saw a 7-point decline in average expense ratios for stock funds. Should that decline be repeated in coming years, the ICI estimates that it could save investors $4.6 billion per year. Stacked up against more than $10 trillion in assets, it is not all that impressive. Still, at least it's in the right direction.

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