Trends in the Expenses and Fees of Mutual Funds, 2011

ICI RESEARCH PERSPECTIVE 1401 H STREET, NW, SUITE 1200 | WASHINGTON, DC 20005 | 202-326-5800 | WWW.ICI.ORG APRIL 2012 | VOL. 18, NO. 2 WHAT’S INSIDE 2 Mutual Fund Expense Ratios Continue to Decline Trends in the Expenses and Fees of Mutual Funds, 2011 2 Equity Funds KEY FINDINGS 4 Hybrid Funds 5 Bond Funds 6 Index Funds 9 Money Market Funds 11 Funds of Funds 13 Mutual Fund Load Fees » On average, expense ratios incurred by investors in long-term mutual funds declined in 2011: equity fund investors on average paid 79 basis points (0.79 percent) in expenses, down 4 basis points from 2010. Expenses of bond funds declined 2 basis points, to 62 basis points. » Expense ratios of money market funds fell in 2011 following a sharp decline in 2010. The asset-weighted average expense ratio of money market funds was 21 basis 18 Conclusion 19 Notes 20 References points in 2011, a drop of 3 basis points from 2010. Expense ratios on money market funds have fallen sharply in the past few years as the great majority of funds waived expenses to ensure that net returns to investors remained positive in the current low interest rate environment. Sean Collins, ICI Senior Director of Industry and Financial Analysis, and Emily Gallagher, ICI Research Associate, prepared this report. Suggested citation: Collins, Sean, and Emily Gallagher, 2012. “Trends in the Expenses and Fees of Mutual Funds, 2011.” ICI Research Perspective 18, no. 2 (April). » In 2011, the average expense ratio paid by investors in funds of funds—mutual funds that invest in other mutual funds—declined 4 basis points to 83 basis points. The total expense ratio of funds of funds includes the expenses that a fund pays directly out of its assets as well as the expense ratios of the underlying funds in which it invests. Since 2005, the average expense ratio for investing in funds of funds has fallen 18 basis points. » The average expense ratio investors paid to hold either index or actively managed funds declined in 2011. Since 1997, the average expense ratio of actively managed equity funds has declined 11 basis points, while that of equity index funds declined 13 basis points. Growing investor demand for index funds has contributed to the overall decline in long-term fund expenses because index funds have lower average expense ratios than actively managed funds. » Load fee payments have declined over time. In 2011, the average maximum sales load on equity funds offered to investors was 5.4 percent. But the average sales load investors actually paid was only 1.0 percent, owing to load fee discounts on large purchases and fee waivers, such as those on purchases through 401(k) plans. This represents a decline of nearly 75 percent from the average load fee investors paid in 1990. Mutual Fund Expense Ratios Continue to Decline Fund expenses cover portfolio management, fund administration and compliance, shareholder services, recordkeeping, certain kinds of distribution charges (known as 12b-1 fees), and other operating costs. A fund’s expense ratio, which is disclosed in the fund’s prospectus and shareholder reports, is the fund’s total annual expenses expressed as a percentage of the fund’s net assets. As opposed to sales loads, which are discussed later, fund expenses are paid from fund assets. Various factors affect a mutual fund’s expenses, including its investment objective, its level of assets, the average account balance of its investors, the range of services it offers, fees that investors may pay directly, and whether the fund is a “load” or “no-load” fund (see “Understanding Mutual Fund Load Fees,” below). Over the past two decades, on an asset-weighted basis, average expenses* paid by mutual fund investors have fallen significantly (Figure 1).1 In 1990, investors on average paid 99 basis points, or 99 cents for every $100 in assets, to invest in equity funds. By contrast, expenses averaged 79 basis points for equity fund investors in 2011, a decline of over 20 percent from 1990. The decline in the average expense ratio of hybrid funds mimicked that of equity funds while the decline of bond funds was more marked, falling 30 percent, from 88 basis points in 1990 to 62 basis points in2011.2 Expenses incurred by investors in money market funds dropped 61 percent, from 54 basis points in 1990 to 21 basis points in 2011.3, 4 Equity Funds Expense ratios of equity funds declined in 2010 and 2011, following a rise of 4 basis points in 2009. This pattern was not unexpected, given recent stock market developments. Expense ratios often vary inversely with fund assets. Certain fund costs—such as transfer agency fees, accounting and audit fees, and directors’ fees—are more or less fixed in dollar terms regardless of fund size. When fund assets rise, these fixed costs become smaller relative to those assets. As fund assets fall, the fixed costs contribute relatively more (as a percentage of assets) to a fund’s expense ratio. During the stock market downturn from October 2007 to March 2009, the assets of stock funds declined markedly (Figure 3, dashed line with an inverted scale), leading expense ratios to rise slightly. As the stock market recovered, stock fund assets rebounded in 2010. This coincided with a 4 basis point drop in average expenses that year. In 2011, fund assets peaked in April. After that, market volatility and sovereign debt crises contributed to a retrenchment in the stock market, but the downturn was not strong enough to knock fund assets off their upward two-year moving average trend—contributing to the 3 basis point decline in average fund expenses in 2011. * In this paper, unless otherwise noted, average expenses are calculated on an asset-weighted basis. See note 1 on page 19. 2 ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 2 | APRIL 2012 FIGURE 1 Mutu�l Fund Fees �nd Expenses H�ve F�llen Since 1990 Basis points, 1990–2011 Equity, hybrid, and bond funds 120 Equity funds 102 Hybrid funds 100 99 80 88 80 79 62 60 Bond funds 40 20 0 1990 1993 1996 1999 2002 2005 2008 2011 Money market funds 75 54 Money market funds 50 25 21 0 1990 1993 1996 1999 2002 2005 2008 2011 Note: Expense ratios are measured as an asset-weighted average; figure excludes mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. Sources: Investment Company Institute and Lipper ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 2 | APRIL 2012 3 Another factor in the decline in the average expenses of long-term funds has been a shift by investors toward no-load share classes, particularly institutional no-load share classes, which tend to have lower-than-average expense ratios. This is due in large part to a change in the way investors compensate brokers and other financial professionals (see “Understanding Mutual Fund Load Fees” below). Hybrid Funds The average expense ratios of hybrid funds also continued a pattern of decline after a sharp rise in 2009. Hybrid funds invest in a mix of equities and bonds. Due to their bond holdings, they are less susceptible to stock market volatility and did not experience a year-over-year decline in assets in 2011. The net assets of hybrid funds rose from $695 billion in December 2009 to $839 billion in December 2011, a 21 percent increase. This was accompanied by a 2 basis point per year decline in average expenses in 2010 and 2011. FIGURE 2 Tot�l Expense R�tios for Mutu�l Funds H�ve F�llen Basis points, 1990–2011 Year Equity funds ™šš› šš ™šš™ ™›™ ™ššœ ™›œ ™šš£ ™›¤ ™šš¡ ™›ž ™ššŸ ™›¢ ™šš¢ ™›¡ ™šš¤ šš ™ššž šŸ ™ššš šž œ››› šš œ››™ šš œ››œ ™›› œ››£ ™›› œ››¡ šŸ œ››Ÿ š™ œ››¢ žž œ››¤ ž¢ œ››ž ž£ œ››š ž¤ œ›™› ž£ œ›™™ ¤š Hybrid funds ™›œ šž šŸ š¢ šš š¤ š¢ š£ š› š› žš žš žš š› ž¡ ž› ¤ž ¤¤ ¤¤ ž¡ žœ ž› Bond funds žž ž¢ ž¡ ž£ ž£ ž¡ ž£ ž™ ¤š ¤ž ¤¢ ¤Ÿ ¤£ ¤Ÿ ¤œ ¢š ¢¤ ¢¡ ¢™ ¢¡ ¢¡ ¢œ Money market funds Ÿ¡ Ÿœ Ÿœ Ÿœ Ÿ£ Ÿ£ Ÿœ Ÿ™ Ÿ› Ÿ› ¡š ¡¢ ¡¡ ¡œ ¡œ ¡œ ¡› £ž £Ÿ ££ œ¡ œ™ Note: Total expense ratios are measured as an asset-weighted averages. Figures exclude mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. Sources: Investment Company Institute and Lipper 4 ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 2 | APRIL 2012 FIGURE 3 Equity Fund Expense R�tios Are Inversely Rel�ted to Equity Fund Assets Expense ratio Percentage points Assets* Billions of dollars, inverted scale 1.05 Expense ratio 0 1.00 1,000 0.95 2,000 0.90 3,000 Assets 0.85 4,000 0.80 5,000 0.75 6,000 1996 1999 2002 2005 2008 2011 *Figure excludes assets of mutual funds available as investment choices in variable annuities and mutual funds that invest primarily in other mutual funds. Assets are plotted as a two-year moving average. Sources: Investment Company Institute and Lipper Bond Funds The average expenses that shareholders paid for investing in bond funds declined by 2 basis points in 2011, to 62 basis points (Figure 2). Bond funds experienced strong asset growth in 2010, which continued in 2011. Bond fund assets totaled $2.9 trillion at the end of 2011, up 10 percent from year-end 2010. As with equity and hybrid funds, growth in fund assets put downward pressure on the expense ratios of bond funds. Two other factors also played a role. ICI RESEARCH PERSPECTIVE, VOL. 18, NO. 2 | APRIL 2012 First, in 2010, investors, seeking higher yields available in a number of foreign markets, increased their holdings of global/international bond funds. Such funds generally are more costly to manage than bond funds with a domestic orientation and thus have above-average expense ratios. Money continued to flow into global/international bond funds in 2011, albeit at a more tempered pace (net new cash flow into these funds was $39 billion in 2011 versus $53 billion in 2010). This comparatively smaller inflow was coupled with nearly a 5 basis point decline in the average expenses of global/international bond funds in 2011— reducing upward pressure on the overall average expense ratio of bond funds. 5 ... - --nqh--