Last week, the Investment Company Institute published a study on fund expenses entitled, "Trends in the Expenses and Fees of Funds, 2016." It says, "The average expense ratios for money market funds rose 5 basis points in 2016 to 0.18 percent. This was indirectly related to the Federal Reserve raising short-term interest rates in December 2015, which prompted fund advisers to begin paring expense waivers that most money market funds offered during the period of near-zero short-term interest rates that had prevailed in the post–financial crisis era."
The report shows average money fund expense ratios declining from 0.52% in 1996 to 0.46% in 2001, 0.40% in 2006, 0.21% in 2011, and a record low of 0.13% in 2014 and 2015. ICI's expense charts source Morningstar and Lipper. (See Crane Data's Money Fund Intelligence XLS for our expense series, and see also ICI's press release, "Equity, Bond, and Hybrid Mutual Funds Continue Two-Decade Trend of Declining Expense Ratios.)
The paper, in a section entitled, "Mutual Fund Expense Ratios Have Declined Substantially over the Past Two Decades," explains, "Fund expenses cover portfolio management, fund administration and compliance, shareholder services, recordkeeping, certain kinds of distribution charges (known as 12b-1 fees), and other operating costs. A fund's expense ratio, which is shown in the fund's prospectus and shareholder reports, is the fund's total annual expenses expressed as a percentage of its net assets. Unlike sales loads, fund expenses are paid from fund assets. Many factors affect a mutual fund's expense ratio, including its investment objective, its assets, the average account balance of its investors, the range of services it offers, fees that investors may pay directly, and whether the fund is a load or no-load fund."
ICI's section on "Money Market Funds," states, "The average expense ratio of money market funds rose to 0.18 percent in 2016, an increase of 5 basis points from the level in 2015.... This marks a reversal from the historical trend in which money market fund expense ratios had remained steady or fallen each year since 1996. From 2000 to 2009, a combination of two factors played a significant role in reducing the average expense ratios of money market funds. First, expense ratios of retail money market fund share classes declined 21 percent over this period. Second, the market share of institutional share classes (which tend to have larger average account balances and therefore tend to have lower expense ratios) rose to two-thirds of total money market fund assets."
It continues, "After 2009, however, other factors had been pushing down the average expense ratios of these funds -- primarily developments that stemmed from the low interest rate environment. Over 2008–2009, the Federal Reserve sharply reduced short-term interest rates. By 2009, the federal funds rate was hovering only a little above zero. Gross yields on taxable money market funds (the yield before deducting the fund's expense ratio), which closely track short-term interest rates, fell to all-time lows. This situation remained in stasis from 2010 to late 2015."
The research piece tells us, "In this environment, most money market funds adopted expense waivers to ensure that net yields (the yield on a fund after deducting fund expenses) did not fall below zero. With an expense waiver, a fund's adviser agrees to absorb the cost of all or a portion of a fund's fees and expenses for a period of time. The expense waiver, by reducing the fund's expense ratio, boosts the fund's net yield."
It adds, "These expense waivers are costly for fund advisers, reducing their revenues and profits. From 2009 to 2015, advisers waived an estimated $36 billion in money market fund expenses.... It was expected that if short-term interest rates were to rise, pushing up gross yields on money market funds, advisers might reduce or eliminate expense waivers, which would cause the expense ratios of money market funds to rise somewhat." Annual waiver amounts peaked in 2014 at $6.3 billion in 2014 and totaled $2.5 billion in 2016. (Waivers no doubt will continue lower in 2017 given the rate hike in March and possible further hikes in June and later in 2017.)
ICI writes, "That, ultimately, is what happened. In December 2015, the Federal Reserve raised the federal funds rate by 0.25 percent, signifying a strengthening economy. In December 2016, the Federal Reserve hiked the federal funds rate another 0.25 percent. Both Federal Reserve actions were reflected in short-term interest rates and hence the gross yields on money market funds. With gross yields rising, there was less chance that the net yields of money market funds might fall below zero."
They add, "Consequently, in 2016, advisers pared somewhat the expense waivers they had provided to their money market funds. For example, at the end of 2014, 99 percent of the share classes of money market funds had expense waivers. That dropped to 88 percent by the end of 2016 and expenses waived dropped sharply from an estimated $5.5 billion in 2015 to an estimated $2.5 billion in 2016."
