2019 Mutual Fund Guide: Profit from These Trends
Funds are lowering expense ratios — and more than ever are free. Here’s how to take advantage of this changing landscape.
Change is inevitable, as Benjamin Disraeli, the 19th-century British prime minister, once said. He was talking about society. But it’s also true in the nearly $16 trillion world of mutual funds—and we’re not just talking about recent gyrations in the financial markets. Take the past year. For the first time in history, mom-and-pop investors can invest in free mutual funds. The four funds, all Fidelity index funds, charge no annual fees. “I used to say expense ratios can’t get to zero,” says Sean Collins, chief economist at the Investment Company Institute, “and I’ve had to change my tune.”
The drop in expense ratios is just one of many shifts under way in the mutual fund industry. Other trends include lower investment minimums, reduced sales loads, an explosion of quantitative strategies, and the ongoing flow of assets out of actively managed funds and into index funds. All told, the mutual fund world has become extremely competitive. Says Brian Hogan, head of Fidelity’s investment product solutions and innovation division: “The pace of change is accelerating. If we don’t disrupt what we’re doing, someone else will.”
We’ll highlight the biggest developments in the fund world today and give advice, where possible, on how best to navigate them. Change is constant. When it comes to mutual funds, that’s been good for investors so far.
1. Ever-lower fees
It’s now a well-worn investing mantra: Fund fees eat into your investment returns. As a result, for several years now investors have been dumping their high-cost actively managed mutual funds for low-cost index mutual funds and ETFs (more on that later). In large part, that’s why mutual fund expense ratios have dropped 40% since 2000, from an average of 0.99%, or 99 cents for every $100 invested, to 0.59% in 2017, the Investment Company Institute says.
That trend will continue. Consulting firm PwC predicts that fees for actively managed funds will fall by another 20% by 2025. Expense ratios for index funds will drop more, by 21%. “Where does it stop?” asks ICI’s Collins. “Are we going to see a world where fund advisers are offering to pay to subsidize expense ratios? I don’t think we really know at this point.”
At Vanguard, the industry low-fee standard bearer, the notion of a zero fee or even a negative fee is not plausible. “It costs something to run a mutual fund,” says Jon Cleborne, a principal in Vanguard’s Retail Investor Group. “There are licensing fees, auditing fees, servicing fees.” His view is that transparency in fees is more important than charging the lowest fee.
Shareholders who pay little or nothing to invest in some funds might end up paying in other ways. For instance, Fidelity’s zero-fee funds, which have pulled in $2.5 billion since their August launch, were designed to attract new customers who would pay for other Fidelity products. “People will buy a combination of products,” says Fidelity’s Hogan, with the firm likely earning fees from follow-on investments in actively managed funds, money market funds, stocks and bonds.
But, as when the four-minute mile was bested, now that the zero-expense-ratio barrier has been broken, you can expect to see more funds with no charge—or close to it. The first zero-expense-ratio ETF may launch this year, predicts Todd Rosenbluth, an analyst at CFRA Research. JPMorgan and Schwab, in particular, have the resources to cut an ETF’s fees to nothing. An increase in assets and higher trading volume, for instance, could offset any potential losses.
But focusing exclusively on fees isn’t always the best strategy. It behooves investors to make sure they fully understand a fund before buying shares and to be confident that it offers the kind of market exposure they seek. “Don’t choose a fund based just on an eye-catching or even zero expense ratio,” cautions CFRA’s Rosenbluth.
For instance, Fidelity Zero Extended Market Index (symbol FZIPX) and Fidelity Extended Market Index (FSMAX) both invest in midsize companies. The Zero fund has a 0% expense ratio, and consumer stocks such as Lululemon Athletica and Advance Auto Parts are among its top holdings. FSMAX, on the other hand, charges a 0.045% annual fee and holds more tech stocks. A cautious investor might prefer the Zero fund; an aggressive investor might favor the other fund.
2. Falling costs elsewhere
Lost in the excitement about Fidelity’s zero-fee fund launch last year were two other pieces of good news for investors: Fidelity eliminated its minimum investment to open a brokerage account (from $2,500), and it lowered the minimum initial investment for all its mutual funds to $1 (from $2,500). To be fair, Fidelity was a little late to the zero-minimum brokerage account party. TD Ameritrade and Merrill Edge already required no minimum to open an account. (Schwab joined the party late, too, last November.) And Fidelity’s latest salvo came well after Schwab trimmed the minimum investment on all of its OneSource, no-transaction-fee funds to $100 (from $2,500) back in 2015.
In any case, in November, Vanguard followed the trend in a slightly different fashion. It trimmed expense ratios for millions of investors by reducing the $10,000 investment minimum for its Admiral share class to $3,000, allowing more investors to qualify for the lower-cost shares. Investing costs across the board “just keep going down and down and down,” says Vanguard’s Cleborne.
3. More unique offerings
Investors can already choose among thousands of funds. That means firms must be creative about the new products they launch.
Funds focused on environmental, social and corporate governance factors will continue to abound. These ESG funds are a draw for investors who want to align their portfolio with their social values. But the investment style is also gaining traction for homing in on specific criteria—such as diversity in the workplace—that many now view as having a material, positive effect on the company’s bottom line (see What You Need to Know About Values Investing).
You may also see new funds that offer exposure to slices of the market we haven’t seen before. DoubleLine Infrastructure Income, for instance, is a three-year-old fund that focuses on a nascent sector of the bond market: financing that funds infrastructure projects, such as commuter rail systems. The firm says the sector offers yields akin to those of intermediate-term bonds, but with less volatility. And Fidelity has filed for approval to launch a fund focused on companies that are run by their founders, a criterion that many solid stock pickers have long said has merit.
Quantitative strategies, which are hugely popular among ETFs, are creeping into the mutual fund world. Such funds follow rules-based approaches or focus on particular market niches, such as small companies trading at bargain prices. “It’s an easy way for mutual fund companies to offer more low-priced products,” says CFRA’s Rosenbluth.
New products can be enticing, but investors would be wise to make sure new funds fit in with their overall investment plan. Be clear about your investment rationale for buying a fund. Will it address a specific goal, such as providing lower volatility or a higher yield? Do you see merit in the fund’s investment approach?
4. Shifting asset flows
Index funds and ETFs continue to draw investors’ money away from more-expensive, actively managed mutual funds. And the trend is unlikely to end anytime soon.
Actively managed funds, especially U.S. stock funds, continue to lose money as index mutual funds and ETFs rake it in. Although index mutual fund assets account for just 20% of all mutual fund assets, actively managed U.S. stock mutual funds have seen net outflows—more money has gone out the door than has come in—every calendar year since 2005, while index mutual funds have seen net inflows. It’s not exactly a dollar-for-dollar exchange, says ICI’s Collins, “but it’s close.”
Meanwhile, ETFs continue to grow in popularity, too, thanks to increasing investor familiarity and a growing group of fee-only financial advisers who prefer these funds as primary investment vehicles. ETF assets over the 10-year period ending in 2017 have increased at an annual rate of 16%; mutual fund assets, by contrast, have grown by 2%. ETFs now make up 19% of all assets in investment funds (mutual funds make up the rest).
Mutual fund investors have been savvy about shifting their assets around. In 2018, they were selling high and buying low, at least with regard to stock funds. Over the 12-month stretch, foreign stock funds took in $25 billion. At the same time, $110.7 billion exited U.S. diversified stock funds. This came as U.S. stocks peaked and foreign markets tumbled: International stock markets gave back 14.2% in 2018, far more than the 4.4% loss in the U.S. market.
Investors are devoting more money to bond mutual funds, too, despite the rise in interest rates in recent months. (Yields and prices move in opposite directions.) Aging baby boomers getting their portfolios ready for retirement and investors nervous about a bear market in stocks are primarily driving this shift, says ICI’s Collins. Indeed, bond fund categories—including intermediate-term bonds, ultra-short debt, municipal bonds and bank loans—dominated the top 10 Morningstar fund categories with the biggest net inflows over the past year.
5. Closed funds reopening
As a result of market downturns or poor short-term performance, funds that had closed to new investors may reopen. It has happened before: In 2008, amid the financial crisis, Fidelity Contrafund, which had closed to new investors in 2006, and Fidelity Low-Priced Stock, which closed in 2003, reopened to new investors. So did Dodge & Cox Stock, which had closed to new investors in 2004. All three funds remain open.
More recently, foreign stock markets have suffered losses, and two solid funds in this category that were previously closed to new investors have reopened. FMI International, closed to new investors in April 2017, reopened in April 2018. In December, Oakmark International, a Kiplinger 25 fund, lifted a restriction that had limited new investors to buying shares directly from Oakmark. “We’ve already seen closed funds reopen, and I think we’ll see more of that in 2019,” says Rosenbluth.
Shrewd investors will keep an eye on good funds that are now closed to investors and may reopen. Two standouts we’re watching closely: Harding Loevner Emerging Markets and Dodge & Cox International.