ETF Opinion: Don't Be Impressed By Falling Mutual Fund Fees

Mutual funds can still say they've got a lot more in combined assets under management than the roughly $1.2 trillion ETFs and ETNs hold, but as the rivalry between mutual funds and exchange-traded products intensifies, more attention than ever is being paid to one of the primary causes of the tussle: Costs. In a note published today Morningstar says mutual fund investors are paid 0.75% in expenses last year compared with 0.77% in 2010." The figures include all open-end funds except funds of funds where the layering of fees can make for messy comparisons, according to Morningstar. The lower fees represent progress to be sure, but at an average expense ratio of 0.75%, that still means investors lose $75 per year invested in mutual funds. Again, progress is progress and no one should complain about seeing their fees lowered, but when the average goes to 0.75% from 0.77%, it's hardly cause for excitement. According to Morningstar data, the average expense ratio for an international equity mutual fund is 0.93%. Sorry, but that's insulting, especially when an investor can own the Vanguard MSCI Emerging Markets ETF VWO and the iShares MSCI Brazil Index Fund EWZ for a COMBINDED 0.79%, 0.2% for VWO and 0.59% for EWZ. That's just one example of an ETF pair that's cheaper than the average mutual fund in a particular category. Morningstar also highlights dramatic fee reductions for a couple of mutual funds including the Wasatch Ultra Growth Fund, which appears to be a mid-cap or small-cap growth fund. The fund "had one of the biggest fee drops as expenses fell to 1.68% in 2010 and 1.42% in 2011 from 1.75% in 2009," Morningstar notes. Please sense the sarcasm: Wow. The The iShares Russell Midcap Growth Index Fund IWP charges just 0.25% while the iShares Morningstar Mid Growth Index Fund JKH has an expense ratio of just 0.3%. The Vanguard Mid-Cap Growth ETF VOT charges a scant 0.12%. Then there is the little matter of something called returns. You know, the reason investors put money into the financial markets in the first place. Well actively managed mutual funds are duds when it comes to returns. Morningstar said earlier this year, just 17% of large-cap mutual funds beat the S&P 500 last year. Remember, you can own the SPDR S&P 500 for less than 0.1% in fees. Not to beat up on the Wasatch Ultra Growth Fund, but over the past five years and 10 years, the fund seriously lags the performance of the Russell 2000 Index. Investors can capture exposure to that index with the iShares Russell 2000 Index Fund IWM, which charges just 0.26%. In other words, IWM is nearly 120 basis points cheaper than the aforementioned mutual fund, but at no time over the past year, year-to-date and in the past month has the mutual fund outperformed IWM by that margin. The debate doesn't revolve around just one fund from Wasatch. Just look at the the top-performing emerging market ETFs over the past five years as illustrated by Kiplinger's. That group has an average expense ratio of 1.54%. For that privilege, an investor might also be subject to redemption fees, not being able to see a fund's holdings updated daily as is the case with most ETFs and, of course, the potential for disappointing performance exists. Morningstar says "costs have come down because of appreciation, inflows, and a shift to lower-cost funds." Let's just come right and say what's really going on: Mutual fund companies are asleep at the wheel, arguably they have been, if they think investors will continue to pay even 0.75% for active management that generates slack results. Assets have to come from somewhere and since ETF assets under management show an upward trajectory, it's reasonable to say plenty of new ETF inflows are new mutual fund outflows. Please feel to contact me for a cordial debate on this subject or just to ask questions. Follow me on Twitter: @ETFProfesor1