Toward the end of 2015, Vanguard's fund boards voted to lower expenses for over 100 funds.
Then, in January, the biggest U.S. mutual fund provider picked up the trend again, announcing that expense ratios for 35 individual mutual fund shares, including 12 Vanguard target-date funds, had been cut.
The expense reductions are a win for investors, the firm says, and it partly attributes the steps for its success: Last year, Vanguard passive index funds attracted a record $236 billion in net deposits.
“We strongly believe in setting our investors up for success, and one of the best ways to do that is to keep the cost of investing low, enabling them to keep more of what they earn,” said Vanguard CEO Bill McNabb in a statement.
But the fund provider industry is less enthusiastic, seeing the fee reductions from Vanguard as a grind to zero where product profitability disappears.
"Fee compression is a theme we’ve seen in our industry for years now and has only been intensified with new players entering the market and the recent growth of robo advisors," says Phil Blancato, CEO of Ladenburg Thalmann Asset Management.
"This is a game we don’t see ending anytime soon and expect it to not only increase in the ETF space, but seep into the mutual fund space as well, which we’ve seen today with Vanguard."
STRONG INFLOWS
The latest batch of funds cutting expense ratios includes the $22.7 billion Vanguard Target Retirement 2035 Fund, which dropped its ratios 3 basis points, according to the Valley Forge, Pa.-based firm. The expense ratios for its target date funds now range from 0.14% to 0.16%.
In a financial symbiosis, low expenses drives growth, which then drives expenses down, says Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ and SNL.
"Due to strong inflows in Vanguard mutual funds, they are able to bring expense ratios down for many mutual funds on a regular basis," Rosenbluth says. "In particular, they have seen demand for target date funds as investors use Vanguard’s already low-cost funds to support retirement programs."
Target-date retirement funds are an area of the market where pricing is really important, said Laura Lutton, director of manager research at Morningstar. "Low price investments have been big winners in the marketplace in general and that's particularly an issue in retirement savings," she says.
Vanguard says it is now the largest manager of target-date fund assets in the industry, managing nearly $358 billion of target-date assets and witnessing more than $56 billion cash flow into its target date mutual funds and collective trusts in 2014.
An investor shift to passive investing has also powered that flow.
Bloomberg reports that in the first 11 months of 2015, passively managed stock mutual funds and ETFs gathered about $257 billion, compared with redemptions of $108 billion for actively run funds, according to Morningstar. On the bond side, funds that track indexes won $93.8 billion, compared with outflows of $25.7 billion for active funds.
'NOT DELIBERATE'
Vanguard's mutual ownership structure also helps it price its funds at cost.
"They don’t really lower expense ratios like a State Street or an iShares might do, where they're making a deliberate cost cut," says Bridget Hughes, associate director of manager research at Morningstar.
"Every year they send a report like this on which funds have achieved lower expense ratios, but it isn’t a deliberate undercutting of a competitive decision to cut costs, necessarily," Hughes says. "It's just because that they have an at-cost model that is unique to the industry. That's just how their expense ratios end up at the end of the year."
Still, some expense ratio reduction in this latest round is not from scale but as a result of competition, Rosenbluth says. "Vanguard’s quantitative equity mutual funds are facing more competition from smart-beta ETFs that have similar approaches. So a lower cost version helps to defend existing business."
Other Vanguard funds reporting expense ratio reductions in January included two actively managed balanced funds, eight fundamentally managed active equity funds, nine quantitatively managed active equity funds and four bond index funds, the firm said.
Vanguard spokesman David Hoffman says continued growth will allow the firm to continue to lower costs on its funds.
"Is there still room for fees to go down? We believe so," he says, pointing out that in 1975, Vanguard was managing $1.8 billion and the average expense ratio was 89 bps; today Vanguard manages $3.2 trillion and the average expense ratio is 18 bps.
'NO FREE LUNCH'
Hoffman said the firm has heard the industry concern about a race to zero expenses. "There are fixed costs to managing funds and ETFs," he says. "We would just say there's no free lunch."
Still, the impact on fund providers is magnified by their scale, Lutton says.
"When they cut fees, that creates competitive pressure elsewhere in the industry," Lutton says. "We've seen examples of other firms that keep a very close eye on costs and will lower their fees to match Vanguard, or to come close anyway.
"This is certainly a positive for the fund holder but it may be a negative for some of Vanguard's competitors from a bottom-line perspective."
Hoffman said the decision to lower expenses of Vanguard funds isn't driven by competitors. "We don’t pick and choose which investors benefit. We try to lower investing for all investors across the board."
