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| | Mutual Funds
Top funds at fire-sale prices
Fidelity has cut fees on some of its index funds, making it easier for investors to make money and putting pressure on rival Vanguard.
By Timothy Middleton
After years of relentlessly rising prices, mutual funds are going on sale.
Last week, Fidelity Investments launched a frontal attack on its rapidly gaining No. 2 competitor, Vanguard Group, by slashing the fees it charges on its Spartan index funds to nearly half of Vanguards level, or less.
They weren't the first cost cuts Fidelity has announced, and they come amid a rash of price-cutting imposed on fund companies such as Alliance Capital after the scandals unearthed by regulators a year ago. The cuts could reverse the direction of fund fees, which have risen steadily for a decade.
The trend, especially among the bigger shops, is to bring their management fees down, says Lucas Garland, fund analyst for Lipper in Denver.
That would provide welcome relief for fund shareholders, whose average expense charge for a diversified equity fund has spurted 13.5% since 1994, to 1.51%. Fidelity will charge 0.1% on five Spartan index funds.
Fee cuts could deliver big gains
The difference over 30 years on a $10,000 investment, assuming annual average gross returns of 10%, would mean a gain of $144,500 for the Fidelity customer, compared with $96,200 for the average investor, a 50% advantage.
If you are a long-term investor, why would you do anything other than Fidelity? says Russel Kinnel, director of fund research for Morningstar in Chicago. He expects the firm to lose money on its Spartan index funds, but to try to more than make that up through growth in assets of its actively managed portfolios, as investors drawn to index bargains bring along the balance of their accounts.
Fidelity said last week it was capping the expense ratios of the following five Fidelity Spartan index funds at 0.1%: Fidelity Spartan 500 Index (FSMKX), Fidelity Spartan Total Market Index (FSTMX), Fidelity Spartan Extended Market Index (FSEMX), Fidelity Spartan International Index (FSIIX) and Fidelity Spartan U.S. Equity Index (FUSEX), which also tracks the Standard & Poor's 500 Index ($INX).
In most cases, that will make them cheaper, and often much cheaper, to own than any rivals. Index funds are a commodity, says Jeff Carney, president of Fidelitys Personal Investments division. We were not competitive; now we are.
| Fidelity expenses vs. the competition | | Fund type | Fidelity | Vanguard | ETF | | S&P 500 | 0.1% | 0.18% | (SPY) 0.10% | | Total Stock | 0.1 | 0.20 | (IYY) 0.20 | | Extended Market | 0.1 | 0.26 | (IWM) 0.20 | | International Idx | 0.1 | 0.34 | (EFA) 0.35 |
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Notes: Vanguard funds have names similar to Fidelitys, except the fund that corresponds to International Index is Vanguard Developed Markets Index (VDMIX). ETFs are S&P 500 Spiders, Dow Jones Total U.S. Market Index, iShares Russell 2000, iShares MSCI EAFE Index. Sources: Morningstar, Fidelity Investments, ETFconnect.com, Barclays Global Investors, Vanguard Group.
A Vanguard spokesman said, Costs are obviously important, but the transactional skill and strategy of the index manager, plus the tax efficiency of the fund, can make a big impact on investors total return over time.
The head of indexing at Vanguard, George Sauter, is an acknowledged master of this art, often getting the jump on other indexers by adding issues like Yahoo! (YHOO, news, msgs) to his funds before theyre officially incorporated into the index.
A spokesman for the foremost issuer of exchange-traded funds, Barclays Global Investors, insisted Fidelitys cuts wont threaten that firms products. Our target market is advisers and high-net-worth individuals who know the difference between ETFs and mutual funds, he says. The heat is on Vanguard.
For all but frequent traders, Spartan funds are clear winners
As far as individual investors are concerned, however, the heat is on ETFs as well as Vanguard. The model portfolio that I report on quarterly uses only ETFs, but I will have to rethink that. S&P 500 Spiders (SPY, news, msgs) are just as cheap as Fidelity Spartan 500 Index, but the Spartan fund equivalents to iShares Russell 2000 (IWM, news, msgs) and iShares MSCI EAFE Index (EFA, news, msgs) cost half as much, or less.
I would also rethink my familys several indexed accounts at Vanguard, except that they arent large enough to meet Fidelitys minimums. Its $15,000 on Spartan Total Market Index, even in IRAs, in contrast to $3,000 (or $1,000 in IRAs) at Vanguard.
Exchange-traded funds must be bought and sold like stocks, for commissions. At Fidelity, there are no transaction fees for its Spartan funds. By the same token, Fidelity limits the number of exchanges a customer can make to four round trips per year, and imposes redemption charges of up to 1% on Spartan index funds held less than 90 days.
For frequent traders, therefore, ETFs will remain superior, despite their higher fees. For everybody else, these Spartan funds have a clear advantage in reducing ownership costs.
Fees could be headed lower still
The fee cuts at the Spartan funds are only the latest step Fidelity has taken to reduce shareholder costs. Last year, it eliminated front-end sales commissions on more than 50 of its funds, from the Select series to Fidelity Contrafund (FCNTX) and Fidelity Low-Priced Stock (FLPSX), making all of its retail offerings no-load.
Meanwhile, regulators such as New Yorks attorney general, Eliot Spitzer, have wrung fee cuts and financial penalties totaling $2.5 billion from complexes caught up in scandals over improper trading.
The sum of these efforts, and others almost certainly being mulled over by rival fund companies, could be to halt or even reverse the inexorable rise of fund expenses.
| Higher and higher fund fees | | Period | Average expense ratio | | 1994 | 1.33% | | 1995 | 1.36 | | 1996 | 1.37 | | 1997 | 1.38 | | 1998 | 1.41 | | 1999 | 1.41 | | 2000 | 1.40 | | 2001 | 1.44 | | 2002 | 1.49 | | 2003 | 1.51 |
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Note: U.S. diversified equity funds.
Source: Morningstar Inc.
These averages somewhat belie the actual burden faced by the majority of fund investors. When they're asset-weighted, meaning the fee on a $10 billion fund counts twice as much as that of a $5 billion portfolio, the average expense ratio last year was 0.96%, according to Morningstar.
While much less than the unweighted average, that is still up 9% since 1999, and still vastly more than Fidelitys new Spartan expenses. The same $10,000 invested in one of these mammoth funds would gain $113,000 over 30 years, still 22% less than the hypothetical Spartan return.
In short, fund expenses remain extravagant. The industry knows they are: Last year, nearly half of all funds were waiving at least a portion of their fees, according to Lipper, in order to be more competitive. It will be competition that drives fees down, and its up to shareholders to fuel that competition by seeking out low-fee funds.
The thriftiest form of investing is indexing, and the cheapest indexer suddenly is Fidelity.
At the time of publication, Timothy Middleton owned or controlled the following securities mentioned in this article: Vanguard Total Stock Market Index.
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