How low can investment fees go? Fidelity launches a race to zero

Fidelity Investments recently announced it was launching two zero-cost index mutual funds, escalating a price race that could leave investors questioning whether to pay mutual fund management fees at all.

“The most meaningful impact of all of this is its effect on what investors expect to pay for broad market exposure, which is now, at least in the case of a pair of Fidelity funds, nothing,” said Ben Johnson, director of global exchange-traded funds and passive strategies research at Morningstar.

Boston-based Fidelity, with $2.5 trillion in its mutual fund and exchange-traded fund assets, has long been known for big-name, actively managed funds such as its flagship Contrafund, run since 1990 by investment star Will Danoff.

But demand for actively managed mutual funds that try to beat the overall market has lagged in recent years as investors have moved to the passively managed, broad exposure of low-cost indexing, which has been the stock-in-trade for Fidelity rival Vanguard Group.

Fidelity and others have broadened their index offerings and increasingly lowered the cost in an effort to hold market share from competitors such as Vanguard and other low-cost vehicles.

“Why pay for something if I don’t have to?” said Fritz Gilbert, who writes a financial blog called the Retirement Manifesto. “I’m cheap. Low cost has been a huge part of my investment strategy.”

Fidelity’s zero-fee funds include a Total Market Index Fund, made up of 3,000 U.S. publicly held companies, and an International Index Fund, made up of several thousand companies in overseas markets. Both began accepting investments Aug. 3.

Fidelity packaged the launch of the zero-cost index funds with an array of cost-saving devices, including zero minimums and account fees. Some industry observers see the zero-cost funds as a direct shot at Vanguard.

“Fidelity is at war with Vanguard,” said Jamie Cox, of Richmond, Va.-based Harris Financial Group. “They are losing assets to Vanguard. This is a way to stop the bleeding.”

Vanguard and Fidelity were neck-and-neck in mutual fund assets as recently as 2010, when Vanguard had $1.3 trillion in assets under management including exchange-traded funds compared with Fidelity’s $1.24 trillion.

Index funds changed all that, upending the mutual fund industry over the last decade as actively managed funds run by stock pickers suffered during the aftermath of the financial crisis. Many investors fled to less-expensive index funds because they felt the active funds did not sufficiently protect them from the downturn.

“Investors said, ‘Why am I paying you, Mr. or Mrs. active manager, 1% when you don’t protect me in a bear market?’” said Jeff DeMaso, director of research at Independent Adviser for Vanguard Investors, in a recent interview. “It’s a great time to be an investor.”

The move toward index funds helped fuel Vanguard’s rise as investors have piggybacked on a bull market in the S&P 500. The Malvern, Pa.,-based giant now has $5.1 trillion in its mutual funds compared with Fidelity’s $2.5 trillion.

Ken Hevert, Fidelity’s senior vice president for retirement, said the two feeless funds are in keeping with the company’s strategy to drive down costs and allow customers to keep more of their money.

“With the launch of the two new zero-cost index funds, as well as reducing the cost on our other index funds, we are the low-cost provider in this country on index funds,” Hevert said.

Even as Fidelity races to zero, the company is not the lowest-cost mutual fund and ETF manager, according to one industry measurement of expenses. Morningstar provided data that show that among the major mutual fund companies, Fidelity fees were 0.46% of assets under management. Charles Schwab charged 0.13%, T. Rowe Price charged 0.69% and Vanguard charged 0.10%.

Why have costs at all?

“Because it costs money to run mutual funds, whether it’s to turn on the lights, employ portfolio managers, trade securities, file legal work with the Securities and Exchange Commission, do research, pay for Bloomberg machines, travel, you name it,” DeMaso said. “Index funds clearly don’t have as many of those costs, but there’s still costs associated with them.”

And good stock pickers, though rare, can earn millions a year whether they beat the market or not.