In Fixed Income, It’s Good To Follow the Fees

Clients are increasingly mindful of fund fees and that’s a good thing. One of the clear benefits of advisors and clients demanding lower fund fees and “voting” with their dollars is that issuers are responsive with many having been diligent in terms of lowering costs, particularly on passive products.

In terms of the “voting” part of the equation, the proof is in the puddings. Data confirm advisors and investors alike gravitate to the least expensive funds.

“In eight of the last nine years, the cheapest 20% of funds across all Morningstar Categories have, as a group, accounted for 100% of the net inflows into all funds,” notes Morningstar. “Money has poured out of the remaining 80% during that time. The sums are staggering: More than $5.4 trillion has flowed into the low-cost cohort during this eight-year span, while $2.6 trillion has been pulled from the remaining funds.”

Still, advisors may be apt to encounter clients that aren’t fee savvy or that have asset class-level questions about fund fees. Against the backdrop of a turbulent fixed income market, some clients may be wondering it’s worth it to pay up for bond exposure. The answer might surprise both clients and advisors.

Fees Always Matter

For advisors, the best course of action is to assume that while all clients love low fund fees (they do), they also aren’t actively keeping with day-to-day expense ratio headlines. Second, in the essence of caution, assume clients are wondering if low fees are as meaningful with bond funds as they are with equity-based products. They are. Perhaps even more so.

“One of the benefits of indexing is its low cost relative to active management. As indexing has grown, investors have benefited substantially by saving on fees and avoiding active underperformance,” according to S&P Dow Jones Indices. These benefits are not limited just to equities but have also extended to other asset classes including the fixed income space, where fees can play a particularly pivotal role.”

Alright, so S&P is the index provider for a slew of bond funds, both index funds and ETFs, so it’s got skin in the game. The company is behind the iBoxx series of corporate bond benchmarks, which serve as the underlying indexes for a slew of funds advisors are familiar with.

Criticism of the firm tooting its own horn is a matter for another day. What’s relevant to advisors is that funds in the U.S. and Europe tracking iBoxx indexes saved investors an estimated $465 million in fees for the decade ending 2022. That’s a big number and it also signals that passive bond fund fees have been consistently lower than the expense ratios on active fixed income funds.

Active Assessment

To be sure, the bond universe is an area in which active management can be beneficial and there are some managers that beat their benchmarks here.

That is to say advisors should be careful about dumping a strong-performing, high-fee bond fund that’s actively managed simply because of a lower fee on a comparable passive product. On the other hand, specific to corporate bonds, active managers have struggled for some time.

“In the 15 years ending in June 2023, 94% of all actively managed General Investment Grade bond funds lagged the iBoxx $ Liquid Investment Grade Index. High Yield results were almost equally disappointing. As indexing in fixed income has gained momentum, bond market participants have benefited from fee savings and avoidance of active underperformance, a powerful combination,” concludes S&P.

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