Study Indicates Costs Influence Investor Selections

The May 2010 Vanguard research report, Costs matter: Are fund investors voting with their feet?, indicates funds in the lowest expense ratio quartile attracted nearly $395 billion of the cumulative cash flow into all equity funds for the ten years ended December 31, 2009, representing 86% of the net assets that went into the two quartiles reporting positive flows. Equity funds with higher expense ratios—those funds in the third and fourth quartiles—suffered net cash outflows of $81 billion, according to Vanguard commentary. Expense ratios were calculated annually using data from Morningstar Inc.  

In addition to looking at all equity funds, Vanguard’s study showed that $94 billion of the net cash flow into all actively managed equity funds was captured by the lowest expense quartile. That represented 55% of the net assets that streamed into the two quartiles recording positive cash flows. Within all traditional equity index funds, the lowest expense ratio received almost $158 billion, or 93% of the net assets that went into the three quartiles recording positive cash flows.   

A higher percentage of ETF assets (59%, or $77 billion) were invested in the lowest-expense quartile. Within taxable fixed income portfolios (actively managed, indexed traditional bond funds, and bond ETFs), the lowest cost quartile garnered more than $319 billion, or nearly 78%, of the net new cash flow into all bond funds.  

“I think this shows there’s much more awareness that costs are a key driver of long-term success,” said Francis M. Kinniry Jr., a principal in the Vanguard Investment Strategy Group, in the commentary. “This is a very positive development for investors, because it shows they are operating in their own best  interests.”  

Other influences on investors Vanguard noted include: 

• Thanks to the media and the Internet, it’s much easier to compare funds, allowing investors to see for themselves that “the most important factor determining relative future investment success is costs,” Kinniry said. 
• Changes to the way financial advisers do business also suggest costs will continue to be important with regard to fund selection. A shift to a fee-based model from a commission-based model—the result partly of greater market transparency—gives advisers greater impetus to recommend lower cost funds. 
• “[L]ow-cost index funds have become a staple on corporate retirement plan menus as a result of both sponsor and participant demand,” according to the Vanguard study. That said, the data suggest that investors factor in costs more when considering an index fund or bond fund than an actively managed equity fund.