Morningstar - Q3 2020 - 18

Dispatches

Global Briefs

A Downturn is a decline in the stock market
from its month-end peak by 20% or more.

An Expansion runs from the end of a recovery until
the next month-end peak before a 20% decline.

A Recovery runs from the month-end bottom to
when the market returns to its previous peak.

TRENDS

Downturn

Marking Two Decades of Falling Fund Fees

Expansion

The average expense ratio paid by fund investors
is half of what it was two decades ago. Between
1999 and 2019, the asset-weighted average
fee fell to 0.45% from 0.87%. Investors have saved
billions as a result.

importance of minimizing investment costs, which
has led them to favor lower-cost funds. Indeed, the
equal-weighted average expense ratio-which
indicates what funds charge irrespective of where
assets are held-was at 1.01% in 2019.

There are several factors that have driven fees
lower. Investors are increasingly aware of the

Intensifying competition among asset managers
has resulted in many cutting fees to vie for market

Recovery

share. Changes in the economics of advice have
also played a role. The move toward fee-based
models of charging for financial advice has been a
key driver of the shift toward lower-cost funds,
share classes, and fund types-most notably
exchange-traded funds.

Return
Asset-Weighted
All
Active

Passive

Equal-Weighted
All
Active

Passive
1.6%

1.08 1.2
1.01
0.66 0.8
0.58
0.45 0.4
0.13
1990

1995

2000

2005

2010

2019

0

Source: Morningstar Direct. Data as of 12/31/2019.

Small-Cap Indexers Not
the Problem
AMERICAS

United States
Some active small-cap managers bemoan the
industry's secular shift toward passive products as
a direct cause of their performance struggles.
The common complaint is that heavy flows
into indexlike or smart-beta products can distort
the prices of small-cap companies due to their
illiquidity. The impact of these flows theoretically

18

Morningstar Q3 2020

outweighs market movements resulting from
the price discovery of other transactions.
In turn, less-attractive index constituents rally
undeservedly, the active portfolios' stocks struggle
to outperform the index amid the overwhelming
force of the passive flows, and managers don't
get rewarded for discovering sound fundamental
companies that may be less prominent in or
excluded from the benchmark.
While this assertion flows logically, research
has not found a relation between flows to passive
small-cap products and active small-cap fund
performance. If this theory were correct,
one would expect periods of high passive inflows

to correlate with weaker active performance over
time. A look into small-cap managers' performance
compared with small-cap asset flows suggests
no causal relationship.
This study considers flows to open-end index
funds and exchange-traded funds categorized
as small-cap. It excludes flows toward total market
funds (which invest in small-cap companies
as well) because they benchmark to different
indexes, making their flows less relevant for
small-cap managers who only try to outperform
the constituents of their own respective
benchmarks. The potential relation stems from
flows to passive vehicles tied to the active
Morningstar - Q3 2020

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