Investors Will Win From Fund Fee Shakeup

Fidelity has widened the gap between what active funds charge and what they ought to charge – and this will benefit investors in the long run

Jeffrey Ptak 14 August, 2018 | 12:55PM

Are Zero Fee Funds the Future?

Fidelity’s zero-fee index funds don’t come as a complete shock, as pundits have been speculating for some time that indexing would one day become a throw-in.

The cost of the cheapest passive funds and ETFs was already hovering just above zero before Fidelity’s move, after all. But it’s still startling to see fund investing cross this particular Rubicon. Indeed, investment products like funds have tended to be viewed not as a means to an end but as a destination themselves. If this doesn’t shatter that illusion, it certainly cracks it.

Yes, it’s true that market-cap indexing is a different kettle of fish altogether: a commodity business won on scale and price, where it makes perfect sense for fees to approach zero. Yet, it’s an open secret in the fund business that many active funds charge a premium for delivering what’s basically just broad-market exposure.

With Fidelity making that exposure free, it only further widens the gap – if more symbolically, than economically – between what active funds charge and what they ought to charge. And with that will come still more fee pressure, consolidation and change.

It’ll also reverberate in the passive investing business and entrench the position of the biggest players like Vanguard and BlackRock.

Industry implications aside, it’s hard to see this as anything but a positive development for investors. If costs threaten successful investing, the shift to zero-fee investing neutralises that threat. Investors stand to keep nearly all of what their fund investments earn and it’s hard to argue with that proposition.

Investors should be aware they are in the middle of a business that’s undergoing a pretty dramatic reordering and transformation. Alpha – outperforming the benchmark – is being pounded by intense competition into beta; investing is increasingly being supplanted by advice; products are being elbowed aside by more-encompassing “solutions”; and costs are being displaced from one area – the fund – to another – the intermediary/adviser.

Technology Will Transform the Industry

The rise of low-cost, unbundled investing and fee-based advice represents a rejection of the “free” that had dominated as the status quo for years. In effect, this most recent shift to “free” is the culmination of a process that’s seen investors try to separate their alpha from their beta, their investment cost from their transaction cost, and their investments from their planning and advice. They don’t want them mushed together; they want them mercilessly pried apart and priced separately.

But if the old “free” left investors with stubbornly high investment expenses from embedded advice and other charges, will the new “free” – where they pay a pittance for their investments but incur other external costs like adviser fees – have similar unintended consequences? That’s the full circle one doesn’t want to see completed, where costs are shifted elsewhere but not truly eliminated.

The good news is that a repeat of the past seems unlikely because of technology. Just as automation has ushered in the rise of low-cost quantitative and passive investing, so too is it likely to enable cheap delivery of advice and dissemination of data and information by which to compare the quality and price of advice.

That process is already well underway, with the advent of robo advisers. In addition, services that track advisor fees are becoming more commonplace. If anything, progress in this area is accelerating, which makes it increasingly likely that the advice business will pass through the same crucible of unbundling and economising that the fund business has.

The new Fidelity zero-fee index funds don’t represent a quantum-leap in low-cost investing, but they continue to march the industry in a direction that puts investors front and centre, where they belong.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Jeffrey Ptak  Head of Manager Research

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