247-The Price Can Go to Zero
For many years, the fees charged by investment managers of mutual funds grew ever so slightly, gradually approaching 1.5%. Over the last few years, though, the growth in these management fees has stopped. In fact, it reversed. Last year the average management fee charged for actively managed mutual funds was 1.38%, or 138 basis points, where a basis point is one tenth of one percent. But that average is badly misleading. It’s misleading because it treats all funds, regardless of size, as the same. When you adjust the fees for the size of the funds, you find that the dollar-weighted average for actively managed funds is now below 100 basis points. Three things have caused this reversal in management fees: low returns in the stock market, the growth of exchange-traded funds (ETFs) and a price war among the biggest players in the market.
The first two of these factors need little explanation. Over the last ten years, an investment in many bond funds out-performed an investment in diversified equity funds. These low returns have many investors focusing on the costs they incur for the management of their money. These costs include transaction fees for trading securities and management fees for the companies managing mutual funds or exchanged-traded funds. The second factor, the growth of ETFs, is somewhat less obvious, but important. ETFs have garnered a significant share of new money invested in equity funds over the last few years. Companies managing ETFs charge low fees for managing these funds because they have very low costs for shareholder servicing and some other administrative functions associated with investment management. Shrewd mutual fund managers have reduced prices in order to manage the gap in pricing they allow for their managed mutual funds compared to comparable ETFs.
These two causes of the fall in prices for investment management now have a third important factor. This third factor may turn out to be the most important of all. (See the Symptom & Implication, “The industry is seeing its first price wars” on StrategyStreet.com.) As described in other blogs (see blogs HERE and HERE), Vanguard has started, and has continued, a price war in the ETF market. For example, iShare’s MSCI Emerging Market’s ETF and Vanguard’s Emerging Market’s ETF compete directly. Vanguard’s fund charges 27 basis points. The iShare’s fund charges 69 basis points. The iShare’s fund entered the market well before the Vanguard fund and was much larger than the Vanguard fund. However, during 2010, the Vanguard ETF added $18 billion to its fund while iShare’s added about $4 billion. Price matters among peers.
The iShare’s funds are not always market share losers, however. The iShare’s Gold Trust is an ETF that competes with a larger rival, SPDR Gold Trust. Until June of last year, both of these ETFs charged 40 basis points. In June, iShares cut its management fees to 25 basis points. SPDR Gold Trust stayed pat at 40 basis points. Over the next few months, the iShare’s fund gained $875 million in new money, while the SPDR Gold Trust saw a net loss of $1.2 billion of money under management. Price matters among peers.
These management fees can even go to zero. One ETF today has no management fee, zero. It gets its revenues by lending out the securities in its portfolio. (See the Symptom & Implication, “Technology improvements bring falling prices” on StrategyStreet.com.)
Of course, as companies engage in price wars, they advertise their lower prices extensively in order to capture as much market share as possible before their competitors respond. The result: customers are becoming ever more price sensitive about the management fees they pay, simply because the management companies tell them to be more sensitive.
How long will it be until this fee warfare spreads to other smaller types of ETFs? Not very long, as long as price moves share.
Investing fees continue to be an issue for investors but not to the extent they were 11 years ago. Industry competition over the last few years has resulted in the elimination of trading fees at virtually all the large trading houses.
On the operating expense ratio side, prices continue under some pressure largely due to the influence of Vanguard and their index tracking ETFs. When pricing is significantly different from one competitor to another, price moves share. For example, the ishares MSCI ETF (EEM), cited in the blog, charges the same 68 basis point management fee it charged in 2011. EEM has $23.6 billion in assets under management. Its primary competitor is Vanguard’s Emerging Market ETF (VWO), also cited in the blog, which charges only eight basis points as its management fee. VWO, with $83 billion in assets under management, is much larger than EEM. Price has certainly moved market share here.
On the other hand, where prices are relatively undifferentiated, nominally low price moves little share. Turning again to the examples in the blog we find that the ishares Gold Trust (IAU) charges the same 25 basis points it charged 11 years ago. It has $25.4 billion in assets under management. However, the much larger SPDR Gold Shares ETF (GLD) has $65 billion in assets under management and continues to charge the same 40 basis point management fee it charged in 2011. Price discounts need to be consequential before they can shift significant market share. In this case, it is likely that the larger fund has a perceived Reliability advantage by being the largest fund in the industry. See HERE for some considerations in setting prices.
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