Jeff Cox | @JeffCoxCNBCcom
The average expense ratio paid by investors — operating expenses divided by assets — in 2016 fell to 0.57 percent, down from 0.61 percent in 2015 and 0.65 percent in 2014, according to a study released Tuesday by Morningstar.
But it wasn’t because the funds themselves were getting cheaper. Instead, investors took advantage of the growing array of options available to them and shifted cash to lower-expense exchange-traded funds.
Indeed, the top 2,000 funds in terms of asset size carried an average expense ratio of 0.72 percent, the same as in the previous two years.
“This indicates that the decline in average mutual fund fees paid by investors stems largely from investors’ migration to lower-costs funds and not from fee cuts by the fund management industry,” Patricia Oey, senior analyst at Morningstar, said in the report.
The record low in fees paid comes amid a massive shift in investor money from mostly actively managed mutual funds to passively managed exchange-traded funds. The key differences are that active funds employ managers who pick individual stocks and can move in and out of positions while ETFs track market indexes and carry substantially lower fees.
In 2016, the average active fund carried a 0.75 percent expense ratio, while passive funds averaged 0.17 percent, according to Morningstar. What’s more, fewer than 1 in 5 active managers beat the basic market index they are measured against. Active fund fees have declined 19 percent over the past three years while active funds have seen fees drop just 6 percent despite the intense competition.
In all, passive funds attracted a net $563 billion from investors during 2016 while active funds gushed $325.6 billion. The flows haven’t been quite as dramatic this year as about half of large-cap managers have been beating their benchmarks.
Investors have gotten considerably more picky when it comes to choosing funds.
In 2015 and 2016, active funds that Morningstar considers the most expensive saw outflows of $627 billion, while the cheapest 20 percent of funds saw inflows of $41 billion.
In terms of individual firms, investors have flocked to Vanguard and BlackRock amid a price war among asset managers.
Vanguard founder Jack Bogle was one of the pioneers of index fund investing, though he is not as big a fan of ETFs. Over the past three years, Vanguard has raked in $739 billion of inflows while BlackRock has taken in $262 billion.
No other firm is close. Overall, BlackRock has $1.13 trillion in ETF assets while Vanguard is next with $711.5 billion and State Street has $521.3 billion, according to ETF.com. The latest data from the Investment Company Institute put total ETF assets at $2.77 trillion while the mutual fund industry excluding money market funds, has $14.3 trillion.