Investors’ preferences for more affordable funds is driving fund fees lower.
The average asset-weighted expense ratio for mutual funds and exchange-traded funds dropped to 37 basis points in 2022, a 7.4 percent decline from a year before, according to the latest fee study by Morningstar. It was less than half of what investors paid in fund fees in 2002, when the average asset-weighted expense ratio for all mutual funds and ETFs was 91 basis points.
The 7.4 percent decrease in fees in 2022 also marks the second-largest year-over-year decline since 1994. Investors paid $9.8 billion less in fees to mutual funds and ETFs in 2022 than they did a year earlier.
“When you have a down market, like the one in 2022, I think that opens up an opportunity for investors to move around money more than when everything’s on the rise,” said Bryan Armour, director of passive strategies research for North America at Morningstar. “That really allowed investors to get into cheaper funds.” During a down market, investors typically recognize capital losses in their portfolios and can use those losses to offset capital gains for tax purposes, potentially leading to a more tax-efficient asset allocation strategy.
Both passively managed and actively managed funds have experienced a notable decline in fees over the past five years, although the reduction was more evident in the latter group. For example, from 2018 to 2022, the average fees charged by active U.S. equity funds decreased by 9 basis points, whereas the average fees charged by their passive counterparts only decreased by 2 basis points. This decline in active management fees corresponds to the underperformance of active funds.
A key driver for the overall fee decline is investor preference for cheaper funds. According to Morningstar, the cheapest 20 percent of funds attracted $394 billion net inflows last year, while the other 80 percent experienced net outflows amounting to $734 billion. It was the first time that the gap in inflows between the most affordable quintile of funds and the rest exceeded $1.1 trillion, according to Armour.
“We saw substantial assets wiped from expensive funds in 2022, as investors poured their money into lower-cost funds to minimize investment costs,” Armour said. “Asset managers have responded to this trend by cutting fees to vie for market share, and the result is a win for investors.”
In 2022, Vanguard continued to be the most affordable fund provider, with an average asset-weighted fee of 8 basis points, followed by State Street Global Advisors (15 basis points), iShares (17 basis points), and Dimensional Fund Advisors (24 basis points).
Fees for funds focused on environmental, social, and governance issues are trending slightly higher than for the average fund. In 2022, the average asset-weighted expense ratio for ESG funds was 50 basis points, compared to the average of 37 basis points for all types of funds. But just like all other types of funds, ESG funds are also seeing a downward trend in fees, with the average expense ratio falling 35 percent over the past decade. The declining fee trend is due in part to the rising number of low-fee index mutual funds and ETFs that focus on ESG, according to the report.