Passive fees “could go to zero”

Can you imagine a world where passive funds are provided free of charge in an ultra-competitive asset management industry? Angana Jacob of S&P Dow Jones Indices (SPDJI) has.

She says that because passive investing is a scale business, “fees can only go one way” and speculates the time may come when large investment houses offer passive fund ranges free of charge, using them as a loss-leader while trying to make active management more profitable.

Jacobs, an associate director at SPDJI, says: “If large players decide to employ a loss-leader strategy to attract investors, we could see business models developing around charging high fees for active and multi-asset business lines, while the cost of core pure passive strategies go all the way to zero.”

Jacob’s comments are in a report she has penned called ‘Fees heading to zero – are we there yet?’, available here.

She notes that in the past ten years 95% of new flows are to the lowest-cost quintile of funds.

Jacobs says that over five years from 2009 to 2014, more than 60% of all funds in the Morningstar database reduced their expense ratio. Actively managed funds in Europe charged 5% less, whereas passive products charged a “staggering” 42% less.

On top of this ETFs have grown 73% in five years, and this rise has been assisted by a massive drop in fees.

Smart beta, meanwhile, is creating a level playing field for returns and fees are the only differentiator.

“Within the smart-beta world, by definition the return of all traditional cap-weighted index funds covering the same market should be equivalent, resulting in beta being commoditised and manager left competing on price alone,” Jacobs said, noting this could result in a “race to the bottom”.

Loss-leading pricing strategies for asset managers, Jacobs says, would be to offer core pure passive ranges for free in order to retain scale benefits, and make profits on smart beta/active products and other business lines, such as multi-asset solutions.

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