The effect of Index Funds Competition on Money Management Fees

Abstract

This paper estimates the effect of competition from low-cost index funds on fees in the money management industry. A difference-in-differences analysis exploiting the staggered entry of index funds finds that while actively managed funds sold directly to retail investors reduce fees by six percent, those sold through brokers increase fees by four percent. Additionally, actively managed funds, especially closet indexers, shift away from holding the index portfolio. A market segmentation model illustrates that beyond a price-competition effect, the index fund entry creates a selection effect that isolates the least-price-sensitive investors and results in a price increase for this group.