The U.S. mutual fund industry controls some $16 trillion worth of assets. Most investors have at least some money in a mutual fund either directly or through a retirement plan. But there are some changes taking place that could have a big impact on the future of the industry. Here are some big issues to watch in 2016.
One of the biggest trends in the mutual fund industry has been the rise of indexed products. These run the gamut from clones of the S&P 500 to more obscure indexes that track specific sectors or niches, like companies with long histories of annual dividend increases. This isn't a new idea; the logic behind it goes back to the efficient-market hypothesis, which suggests that stock pickers can't consistently outperform indexes. However, it's been building steam in recent years. Investors are voting with their money, and they are choosing, more and more, to index.
This brings us to another big trend affecting mutual funds: the rise of ETFs. These investments are similar to mutual funds in that they allow investors to buy a portfolio of assets, but unlike mutual funds, they trade all day long. They also have significantly lower fees than mutual funds.
ETFs are the first product to pose a competitive threat to the open-end mutual fund structure. And they are, for the most part, based on indexes today. That means ETFs are in the sweet spot of investor interest, lower costs, and trading advantages over mutual funds. According to the Investment Company Institute, as the mutual fund industry was seeing net outflows late last year, ETFs were seeing large inflows.
That said, ETFs, with a touch over $2 trillion in assets in them, have a long way to go before they unseat mutual funds as the dominant investment vehicle. But ETFs are gearing up to take mutual funds on more broadly, aiming to offer true actively managed products. Eaton Vance, for example, is launching a series of actively managed ETFs under the NextShares banner. That would basically put the two products on equal footing and could hasten investors' flight from funds to ETFs, especially if actively managed ETFs offer notably lower fee structures.
So, looking at these trends, what might one expect for 2016? First off, the biggest impact on assets this year is likely to be market related, if the first month of the new year is any indication. If the market keeps floundering, investors will probably pull money out of equities and move it to cash or bonds. But underneath those headlines is a huge amount of pressure on mutual funds to compete with index products, ETFs, and each other.
Because profit margins on index funds are slim, look for the largest asset managers to gain more clout. In other words, leaders like Vanguard will probably keep getting bigger. And expect the big players to use their size to push costs even lower than they are today in order to cement their competitive advantage. Vanguard, for example, trimmed expenses on 53 funds in December and another 35 in January. Although the cuts only amounted to a few basis points, the longer-term impact will pressure the entire industry. And that will make it harder and harder for small funds and their sponsors to compete. So the big will get bigger, and your costs will probably go down.
Also keep a close eye on the ETF space. The low cost of these products is putting additional downward pressure on mutual fund fees. But if a model for actively managed ETFs is established, then you're likely to see mutual fund shops offer ETF versions of their top actively managed open-end mutual funds. That, in turn, could hasten the shift to ETFs.
But as investors switch to cheap index funds, whether they're mutual funds or ETFs, the fight for assets among mutual fund sponsors will probably intensify. Given the importance of cost management, you could start to see smaller funds merge with larger ones, while laggard funds may decline more quickly than might previously have been the case. In the end, your investment options could shrink. With so many thousands of mutual funds and ETFs available today, you probably won't notice, but it's a trend that's worth watching over the long term.
Change is in the air
As 2016 gets under way, the boring old mutual fund industry is likely to feel increasingly threatened by investors shifting to index products and the continued rise of ETFs. That will push changes that could materially alter the fund landscape over the long term. In fact, the fund industry will have no choice but to change, lest it bleed to death from a thousand cuts.