The Race to the Bottom
In today’s economy, consumers demand everything be delivered better, faster, and oftentimes cheaper. The asset management industry is no exception. Providers of mutual funds and ETFs have been engaged in a fee war for several years in the “the race to the bottom”. Investors have reaped the benefits throughout this transition. According to Cerulli, an investment management research firm, U.S. equity funds saw asset-weighted fees fall from 0.85% in 2012 to 0.72% in 2017. All along the way, BDF has been using funds which are substantially less expensive than those averages.
There are a few major trends that have caused the market to move in this direction.
Competition: There are many more investment vehicles competing for attention, shelf space, and new dollars. In order to differentiate themselves, many providers have chosen to compete via lowering fund expenses. Some are even offering discounted fees for a set period of time, only to go up later, to woo initial investors.
Passive Management: The shift in the past decade from active to passive management has disrupted the investment world. Active funds typically have higher expenses than their passive peers. As more assets shift to passive managers the total fees have been brought down, but also active managers have been forced to re-evaluate their own fee structures to compete.
The competition has become so heated that the race to zero was officially breached when Fidelity launched their suite of mutual funds with zero fees. These vehicles offer a passive approach to several different equity markets. But how are they able to offer a product that doesn’t have any cost?
Increased Technology: Before technology improved the productivity in the investment world, information was difficult to discover and trading was expensive. Firms have leveraged technology in order to maintain their profit margins at lower fund costs.
Securities Lending: When an investor wants to sell a stock short, they must borrow that stock. Just like a mortgage, the lender receives interest on stock they have lent out. Acting like a bank and lending stocks to short sellers has become a big business for many investment funds. This helps to bring in revenue outside of management fees. Other funds out there pass these earnings on to the investor, but to offer 0%, Fidelity can keep these for themselves.
Loss Leader/ Market Share: For some firms, having a fund that may be a loss leader, but can allow for an increase in assets and market share is a strategic initiative. This strategy can lead to other service offerings or revenue streams outside of the typical fund expense.
Just like any industry, the asset management industry is constantly changing and evolving. This has benefited investors as fund expenses have continued to decrease. However, it is important, just like with any other major purchase, to understand the value that each investment can bring. We all have had experiences where we have realized that cheaper is not always better, but it can catch your attention nonetheless!
Matt is a Wealth Manager at BDF and leads the Financial Professionals Practice Group and serves as the Director of Client Experience and Growth. He serves as the personal CFO to families, private equity professionals, investment bankers, and asset managers. Matt loves to help make the complex simple and help clients enjoy a full life.