Morningstar - Fall 2019 - 51

EXHIBIT 2

Fee War Looking at equal-weighted average fees reveals how far prices have
dropped for index funds, especially in U.S. and international equity categories.

Vanguard Defends
Its Position as
the Low-Cost Leader

Equal-Weighted Average Fees (%)
Active

Passive

2015

2016

2017

2018

2015

2016

2017

2018

US Equity

1.21

1.19

1.16

1.12

0.60

0.56

0.51

Sector Equity

1.44

1.43

1.40

1.37

0.49

0.48

0.47

Allocation

1.17

1.18

1.12

1.10

0.82

0.71

0.97

0.88

International Equity

1.40

1.36

1.32

1.27

0.59

0.56

0.53

0.50

Taxable Bond

0.97

0.95

0.91

0.89

0.29

0.28

0.26

Municipal Bond

0.91

0.89

0.88

0.83

0.33

0.31

0.28

0.27

Alternative

1.77

1.72

1.61

1.47

1.45

1.46

1.44

All Funds

1.21

1.19

1.15

1.11

0.70

0.68

0.64

0.63

Source: Morningstar Direct. Data as of 12/31/2018.

On the flip side, we've seen all other funds-the
remaining 80% of funds sorted by cost-
hemorrhage assets. Indeed, flows have been
negative for five years running for funds in
this cohort, and 2018 was no exception; they saw
a record $478 billion in outflows.

In 2018, Morningstar introduced the "service-fee
arrangement" data point in our U.S. funds
database, which classifies fund share classes as
"unbundled," "semibundled," or "bundled"
based on whether and how they bundle in fees
that pay for advice.

Of the $605 billion that flowed into the cheapest
20% of funds in 2018, 97% of it went into
the cheapest of the cheap, the least costly 10%
of all funds ( E X H IB IT 4 ). Because of these
trends, 83% of all assets are in funds whose fees
rank among the least-expensive 40% of
their respective category groups. Meanwhile, just
7% of investors' money is in the most expensive
40% of funds.

Unbundled share classes charge investors
for investment management and fund operating
expenses only. The fund and its advisor do not pay
third parties to sell their funds to the public.
Unbundled share classes reduce the potential for
conflicts of interest.

Evolving Economics of Advice
The shifting advice business is driving flows
and, by extension, fee trends. As advisor
compensation moves away from commissions
and toward basis-point fees, advisors
are avoiding share classes that embed advice
and distribution costs. In addition, amid
a shift from investment management to planning,
many advisors are emphasizing asset
allocation over security selection. These trends
have spurred demand for cheap, widemarket exposure, which has favored low-cost
passive funds.

Semibundled share classes charge investors
for investment management and other operating
expenses and indirectly charge for sales
distribution (in the form of revenue sharing), but
they don't levy 12b-1 fees.
Bundled share classes charge investors for investment management and other operating expenses;
they also levy 12b-1 fees, loads and commissions,
transactions, and other operational fees.
These share classes are purely transactional.

Among the ranks of the largest asset
managers, Vanguard continues to claim the
low-cost crown. In 2018, the firm's assetweighted expense ratio was 0.09%, down from
0.1% in 2017. Vanguard was followed by
State Street (0.17%) and BlackRock/iShares
(0.3%). However, Vanguard's competition
continued to gain ground in 2018. While the firm
remains the overall low-cost leader, its
competitors have either matched or undercut
the firm's fees for certain broad marketcap-weighted index funds. As these firms have
jockeyed for position, investors have come
out in front, benefiting from an everwider menu of ever-cheaper options offering
wide market exposure.

Fee Competition Has Intensified Among
the Largest Asset Managers
Asset-Weighted
Avg Fee (%)
2018

Market
2017 Share (%)

Vanguard

0.09

0.10

24.7

BlackRock / iShares

0.30

0.33

9.4

American Funds

0.61

0.64

8.5

Fidelity

0.48

0.51

8.3

State Street

0.17

0.18

3.5

T. Rowe Price

0.68

0.69

3.2

DFA

0.34

0.35

2.2

PIMCO

0.62

0.64

2.0

Franklin Templeton

0.83

0.86

1.9

Invesco

0.60

0.66

1.8

Source: Morningstar Direct, Morningstar Research.
Data as of 12/31/18.

Bundled share classes have seen outflows for the
past five years, while semibundled and
unbundled share classes have seen steady inflows
( E X H I B IT 5 ). This corresponds to the shift away

Morningstar - Fall 2019

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