A Vanguard study on mutual fund and exchange-traded fund purchasing activity has revealed that lower-cost products have attracted the predominant portion of investor dollars over the past decade.
In “Costs Matter: Are Fund Investors Voting With Their Feet?,” Vanguard found that in each of five categories, investors favoured funds with lower expenses, directing between 55 per cent and 93 per cent of cumulative net cash flow to the lowest-expense quartile of funds.
The percentage of cumulative cash flow invested in the lowest-expense quartile for the fund category index equity was 93 per cent, equity 86 per cent, bond 78 per cent, ETF equity 59 per cent and active equity 55 per cent.
“It is clear from our analysis that investors are increasingly gravitating toward low-cost funds and ETFs,” says Francis Kinniry, Jr., principal, Vanguard Investment Strategy Group. “The trend to low-expense funds is very encouraging. Low investment costs, along with time and savings rate, should be the focal points for investors as they seek to accumulate sufficient wealth for retirement. Costs are also important to the retired investor, as high costs can substantially reduce one’s income stream and principal balance over time.”
Kinniry says the growing popularity and availability of index funds and index-based ETFs likely fuelled the flight to low-cost products. A similar shift took place among actively managed funds, as lower-cost active equity funds attracted more assets relative to their higher-cost counterparts.
Other reasons for the movement toward lower-cost funds include the large role that financial advisers and corporate retirement plan sponsors play in the fund distribution process. Some 80 per cent of fund assets are held through these intermediaries, which are increasingly offering low-cost products to their clients and participants, respectively. In the adviser market, a move from a transaction-oriented, commissioned-based model to a fee-based model likely abetted the low-cost trend.
The movement could also be caused by a volatile financial market environment that led to greater recognition by investors that 1) costs matter and 2) costs are a controllable factor in the investing equation. By contrast, the historically generous stock and bond returns of the 1980s and 1990s resulted in investors focusing on high absolute returns and paying little attention to costs.
In addition, increased investor understanding of cost, aided substantially by improved disclosure, the greater availability of cost information online, heightened scrutiny of costs by the financial media, and the emergence of costs as a selling point in fund marketing efforts, has also caused the movement toward lower-cost funds.