Morningstar Magazine - February/March 2015 - 44

Spotlight: Fees

use these funds for short-term asset-class
exposure and hedging. These funds are often
early entrants. Once they build a liquidity
advantage over their peers, there may be less
pressure on their fees.
The asset-weighted expense ratio comparison
narrowed ETFs' cost advantage in every
category. Only three of the 14 ETF categories sport
a lower asset-weighted expense ratio than
their mutual fund counterparts. They look more
expensive in eight of the categories.
Assessing Share Classes

Index mutual funds' institutional share classes
pull the asset-weighted average expense
ratio down. However, they require high minimum
investments or are only available on select

retirement-plan platforms. To separate these
restricted share classes from those that are broadly
available to individual investors, we grouped
the mutual fund share classes by minimum
investment. Those with a minimum investment of
$10,000 or less fell into the retail category,
and those with minimums above this threshold
went into the institutional group. We also
categorized all share classes that require an
intermediary to access them as institutional. Each
retail and institutional category needed at least
three funds in order to remain in the sample.
On an asset-weighted basis, ETFs were
slightly cheaper than the mutual funds' retail
share classes in six of the 10 categories
included ( EXHIB IT 2 ). However, the institutional
share classes were cheaper than the ETFs in

EXHIBIT 2

ETF Cost Advantage Against Fund Share Classes On an asset-weighted basis, ETFs

were cheaper than the funds' retail share classes in most categories. That was not
the case with institutional share classes.
Asset-Weighted

Equal-Weighted

Institutional

Retail

Institutional

Retail

Emerging Markets

-0.22

-0.16

0.17

0.03

Foreign Large Blend

-0.12

-0.06

0.20

0.24

0.01

0.05

-0.02

0.01

0.28

0.24

Large Blend

-0.02

0.04

0.26

0.59

Large Growth

-0.07

0.07

0.72

-0.04

0.00

0.51

0.23

Mid Blend

-0.05

0.01

0.36

0.33

0.51

0.87

Small Blend

-0.02

0.04

0.42

0.67

Small Growth

-0.11

0.95

Small Value

-0.09

-0.04

0.93

1.12

The Vanguard Factor

The results of this analysis are also sensitive to
whether Vanguard funds are included. Because
Vanguard prices its funds at cost, many of
its index mutual funds are cheaper than ETFs from
other providers. Vanguard's index funds
have significant influence on the asset-weighted
averages because they tend to be among the
largest mutual funds in each category. However,
Vanguard has a smaller share of the ETF
market. Vanguard funds accounted for 80% of the
assets in our index mutual fund sample and
32% of the assets in the ETF group.
After removing Vanguard's funds, ETFs look
cheaper than their mutual fund counterparts on
an asset-weighted basis in every category
included except foreign large blend. The assetweighted expense ratios for Vanguard's
ETFs are slightly lower than the corresponding
values for its mutual funds. All of Vanguard's
U.S. ETFs are separate share classes of
its mutual funds. Vanguard charges the same
expense ratio for the Admiral and ETF
share classes.

0.95

Large Value

every category except for mid-growth. ETFs
look like a better bargain on the equal-weighted
expense ratios, though the institutional share
classes narrowed the gap in five categories.

Inflation Protected Bond
Intermediate Bond
Long Gov Bond

Mid Growth
Mid Value

A positive number means ETFs had a cost advantage by that amount; a negative number means they were
more expensive.
Data as of the end of each fund's fiscal 2013.
Source: Morningstar

Morningstar February/March 2015

Fee Trends

We extended our analysis back 10 years to uncover
fee trends, including funds that are no longer
surviving. As before, each category had to have at
least three funds to qualify for inclusion.
Based on these funds' annual reports from
2004 through 2013, ETFs' asset-weighted cost
advantage relative to their index mutual
fund counterparts in the large-blend category
fell to 0.01% from 0.10%. As EXHIBIT 3 illustrates,
this was almost entirely due to a decline
in asset-weighted index mutual fund expenses.
For context, we also included in the exhibit
the equal-weighted expense-ratio history for the
large-blend category.
During this time, some of the most expensive
index mutual funds shut down and new
funds entered with lower expense ratios. However,

Morningstar Magazine - February/March 2015

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