Are fee free index funds on the way?

Could Australia one day see a truly fee free index fund investment?

It is a live question after the investment giant Fidelity Investments this week caused the shares of many of its competitors to plunge after it announced some fee free index funds.

The impact was immediate with share prices of other asset managers plunging, including BlackRock, down 4.6 per cent, Legg Mason Inc, down 4.3%, and T. Rowe Price Group, down 1.5%.

While the Fidelity investment funds will only be offered in the United States, the move towards lower fees is a global one and could one day land here in higher fee Australia.

Last week we looked at the effect of fees on superannuation following the decision of BT Investments to cut its platform fees.

We have also seen industry funds use lower investment fees as a way to top the league tables for superannuation returns.

How do you make money with no fees?

So how does a company make money by selling a fund with no fees?

It is a question that left a lot of fund managers scratching their heads but the majority believe the no fee funds are designed to drag business through the door and upsell those customers into other investment options and services that do charge fees such as financial advice and active funds.

There is also some speculation that by growing the scale of the index funds, Fidelity could generate and keep income by lending out some of the shares to other investors for a fee.

In some ways Fidelity didn’t have a lot to lose by becoming a fee-free pioneer because competitors such as BlackRock and Vanguard had long been offering lower fees on index funds and stealing customers away, using these low cost index funds as a loss leader.

Now it is Fidelity’s turn to try to grab back some customers for its active funds which have been shedding customers to competitors.

Australia not in the fee free zone…yet

Australia has had some attempts at no fee superannuation funds with ING Direct’s launch of a balanced fund with no administration or management fees way back in 2011.

Strictly speaking the fund wasn’t entirely fee free because it charged buy/sell spreads on units, which are a cost borne by investors.

ING Direct also credited A$5 million to Living Super customers in 2016 after concerns were raised by ASIC that customers might have thought interest paid on their cash options would be eligible for ING DIRECT’s highest variable savings rate, including any bonus rates, when lower interest rates were actually paid.

Local ETF provider BetaShares has also pioneered an ASX 200 ETF (ASX: A200) with incredibly low management fees of just 0.07 per cent a year in an attempt to gain on some of the really big ASX 200 ETF players such as State Street (ASX: STW) and Black Rock (ASX: IOZ).

So we may not yet have a true zero fee fund trading on the ASX yet or able to be selected as a superannuation fund but the competition to cut fees has begun and hopefully one day Australian investors will be able to buy some ASX index funds for management fees that are at least so low that brokerage becomes the main expense.