With broad market-cap-weighted index strategy managers driving expense ratios close to, if not down to zero, there seems to be a growing voice in the fee debate that the race to the bottom is slowing. Despite this, the downward trend of investment product fees shows little sign of abating, according to research from Cerulli Associates, a global research and consulting firm. To remain competitive, advisors must evolve their definition of advice to include nonfinancial aspects of the clients life and curate a meaningful experiential process for their clients.
Overall, mutual fund and exchange-traded fund (ETF) asset-weighted average total net expense ratios declined consistently during the past five years, from 62.3 basis points (bps) in 2014 to only 46.0 bps in 2018. Fees are driven downward by investor demand for low-cost index products, which have seen fees compressed to at or near zero, says Brendan Powers, associate director at Cerulli.
While decreased fees have led to decreased revenue, Cerulli warns that non-overt revenue compression will also exist. Powers explains, Distributor platform consolidation, product rationalization, and greater advisor use of asset allocation models mean that a higher percentage of assets and flows will move through a smaller number of products.
It is quickly becoming apparent that fee compression still has some room to run. Particularly within index funds, product manufacturers see cost as a competitive edge and increasingly use fees as a marketing tool, continues Powers. As ETF issuers aggressively jockey to offer the lowest fees, we begin to see them filing for-and now launching-zero- or negative-fee ETFs.
Cerulli expects that the increased use of institutionally priced share classes in the retail client channels will also continue to be a factor in driving net expense ratios lower. Recent Cerulli data shows that 65% of advisors agree they intend to use lower-cost share classes, which is expected to increase adoption of platform share classes and institutional share classes. However, the adoption of those that exclude sub-transfer agent (sub-TA) fees has been extremely limited, Powers adds. Therefore, sub-TA fees remain a sticking point for distribution platforms that need to be reimbursed for cost incurred related to accounting and infrastructure to maintain them.
The use of low-cost products and share classes excluding 12b-1 and/or sub-TA fees will change client-facing fees and the flow of revenue sharing between asset managers and distributors. Early examples of these changes include charging the client a platform fee that can be reimbursed through some form of revenue sharing or charging an infrastructure fee to asset managers that participate on a distributors platform. Powers suggests, Ideally, transparency should be the top priority for these and other new arrangements.