Index Fund Entry and Financial Product Market Competition
61 Pages Posted: 23 Oct 2017 Last revised: 22 Jul 2019
Date Written: July 15, 2019
Abstract
The active money management industry has been characterized by both strong competitive pressure from passive investment vehicles and high fees. This paper investigates how the introduction of low-cost index funds affects fund company strategies. The retail mutual fund market is segmented, where unsophisticated investors rely on financial advisers, and sophisticated ones invest directly. Exploiting the staggered entry of low-cost Vanguard index funds as competitive shocks, I show that in response to competition, incumbents sold to self-directed investors reduce their fees by five percent of the mean; however, funds sold with broker recommendations increase their fees by six percent of the mean. The index fund entry also slows the growths of actively managed funds. The responsiveness of broker-sold fund flows to distribution fees increases, suggesting a shift in composition towards less elastic consumers. Further, incumbents increase the degrees of active management. The results illustrate why mutual fund fees decline slowly in the aggregate despite the competition from lower-cost alternatives.
Keywords: consumer finance, mutual fund competition, market segmentation, financial innovation, financial advice
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