By Tim McLaughlin
Boston-based Fidelity Investments rocked the industry this summer by offering no-fee index funds. Some analysts see a future with negative fee index funds, where investors get paid a small amount for investing money.
Morningstar analyst Ben Johnson calls the fee cuts a democratizing force for small investors. "Mom and pop are getting what large institutions get," he said.
The big cuts have come at index funds. Now big drops are likely at actively managed stock and bond funds, whose expense ratios have remained relatively high despite a seismic shift of money into cheaper index funds and exchange-traded funds since the Great Recession. (Graphic: https://tmsnrt.rs/2xSmvib)
The outflow is already pressuring the bottom lines of money managers dependent on actively managed funds, and the squeeze will intensify as their fees continue dropping, executives said.
"It is inevitable that active management sees this reality of investors going to lower cost products," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA. "They will bring down pricing to being only modestly above index funds versus being significantly higher."
Even a fee decline of only hundredths of a points translates into huge investor savings on a U.S. fund asset base of more than $22 trillion. Investors saved about $4 billion in 2017 as overall asset-weighted fund fees dropped to 0.52 percent from 0.56 percent. The 8 percent annual decline was the biggest since research firm Morningstar Inc started tracking those fees in 2000.
Al Blest, a self-employed general contractor in St. Louis, started weeding out expensive mutual funds from his portfolio two years ago after reading a book that detailed how fees can erode retirement savings.
"It amounts to a lot of money over time," Blest said. "The fee base is the first thing I look at when I consider buying a mutual fund. You want as much as that money going in your own pocket."
Since the end of 2009, annual expenses on stock mutual funds have dropped to 0.59 percent of assets from 0.87 percent, according to the Investment Company Institute in Washington D.C. For workers tucking away $20,000 a year in a 401(k) account, the lower expense rate means they would have nearly $100,000 extra in their accounts after 30 years. That assumes an annual rate of return of 6.41 percent.
MORE PAIN AHEAD?
Funds run by stock pickers have endured massive net withdrawals since the end of 2015, totalling $560 billion, according to Morningstar research. Popular bond funds have been hit, too. The $35 billion Templeton Global Bond Fund's annual management fees have dropped 48 percent to $163 million over the past three years, fund disclosures show.
Parent company Franklin Resources Inc has been on the ropes from heavy withdrawals. Its stock is down 26 percent over the past 12 months, even while the S&P 500 index gained 16 percent. The company declined to comment.
Stock analysts at Morgan Stanley see more pain for the industry, especially among mid-size money managers, such as Waddell & Reed Financial Inc and Janus Henderson Group plc. The two firms' fee income will decline 16 percent and 15 percent, respectively, during the next three years, according to Morgan Stanley's base case forecast. Waddell & Reed and Janus Henderson did not return messages seeking comment.
Fund executives expect to see more consolidation among struggling asset managers.
"We've never been more active than we are now in terms of assessing (M&A) opportunities," said Great-West Lifeco Inc Chief Executive Paul Mahon during an Aug. 1 conference call. Great West owns Boston-based Putnam Investments, which had a $6 million operating loss in the second quarter.
Tom Hoops, head of business development at Legg Mason Inc, said his company has spent the past five years adding new investment strategies, such as emerging markets and private equity, via acquisition.
To combat withdrawals, mutual fund heavyweights like Fidelity and T. Rowe Price Group Inc have shifted billions of dollars into collective investment trusts, which are cheaper than mutual funds, but offer the same investment strategies and portfolio managers. CITs cost less because they are not regulated by the U.S. Securities and Exchange Commission. That means they do not have to provide prospectuses or install independent boards of directors, removing layers of expense.
Fidelity's $135 billion Contrafund, run by Will Danoff, charges an expense ratio of 0.74 percent. The expense ratio on the Contrafund CIT is 42 percent less. Workers invested in retirement plans offered by Apple Inc, General Motors and Microsoft Inc, for example, already are getting discounted fees on Contrafund CIT assets totalling $26 billion, regulatory filings show.
Besides shifting money into CITs, T. Rowe said it has carried out direct fee reductions and expense caps on many of its investment strategies, said Flemming Madsen, T. Rowe's head of product. And the company has introduced lower cost share classes for its mutual funds, a move being adopted throughout the industry.
CFRA's Rosenbluth said a downturn in the stock market could accelerate fee compression in the fund industry. "With a 9-year bull market, some fund firms haven't seen their way to bringing prices down," he said.
(Reporting By Tim McLaughlin; Editing by Neal Templin and Paul Thomasch)
(This story has not been edited by Business Standard staff and is auto-generated from a syndicated feed.)