Index Fund Entry and Financial Product Market Competition

61 Pages Posted: 23 Oct 2017 Last revised: 22 Jul 2019

See all articles by Yang Sun

Yang Sun

Brandeis University- International Business School

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

Suggested Citation

Sun, Yang, Index Fund Entry and Financial Product Market Competition (July 15, 2019). Available at SSRN: https://ssrn.com/abstract=3056701 or http://dx.doi.org/10.2139/ssrn.3056701

Yang Sun (Contact Author)

Brandeis University- International Business School ( email )

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