Forecasting a Storm of Questions about Zero-Fee Funds

It may not be two tropical storms about to collide, but the news of Charles Schwabs’ earnings report out in mid-July questioning whether zero fee models can be sustained was nipping at the heels of a case potentially pending before the Supreme Court on fees. The combination of the two could have a major impact. Batten down the hatches because the winds of change could be coming.

Charles Schwabs’ July 2020 earnings report had a noticeable impact on its stock price (reported at 2% in Axios) but the report itself made news for whether the zero-fee model that Schwab uses is sustainable. That could be excellent news for advisors who have been pushing back on the pressure to lower fees. Back in 2017, BCG’s Beau Adams wrote [1] that more clients were willing to pay for fees, rather than commissions. “In a recent poll conducted by Cerulli Associates, a Boston-based research firm, 50% of investors agreed with this statement: ‘I am willing to pay for advice regarding my financial investments.’” But by 2018, we reported hearing that the pressure on advisors to lower fees was ramping up. “Some in the market note that downward pressure on fees is now ‘relentless.’” [2]  Some market industry experts, like Flowspring’s CEO Warren Miller, even predicted that fees could land beyond zero. “Negative fees are coming.”

Many large companies offer zero-fee index funds, including BlackRock, Fidelity, State Street and Vanguard in addition to Schwab. The amount of investments in low fee or near zero-fee indexes and funds can’t be overstated.  As CNBC stated “Of the roughly $80 billion in ETF flows in the third quarter, $57.1 billion went into ETFs that charge 10 basis points (0.10%) or less. Another $16 billion flowed into ETFs charging between 11 and 20 basis points; and $13 billion to ETFs charging 21 to 40 basis points, according to Bloomberg data.”[3] Fidelity has four zero-fee index funds. Or perhaps soon, will have had.

A deep dive into Schwab’s earnings may show why zero-fee funds may be a thing of the past decade. Schwab reported that it’s revenue dropped 9% from $2.62 billion to $2.45 billion with a corresponding drop in net income revenue of 23%. As some noted, Schwab acquired USAA’s investment clients in May of 2020. That netted an additional $1.8 billion of assets under management (“AUM”). That means Schwab lost money even when it gained additional AUM.

While it’s not yet clear whether the Supreme Court will take the case, the allegations involved in the petition raise interesting questions about the scrutiny of fees. The case, Hughes v. Northwestern University, (Supreme Court docket number 19-1401) involves whether a defined-contribution retirement plan charged it’s participants fees that exceeded those on available products which would have violated ERISA.  Under the plans at issue, no participant was required to invest in any specific product. There, plaintiffs did not establish any recordkeeper who would have performed services for fees that were lower, relying on hypotheticals.

The questions involved in Hughes may seem like they center on legal issues, such as which party has the burden of establishing whether fees were reasonable or not. Those issues are most likely what will determine the case. However, much of the case involves the fiduciary duty of prudence. Commonly, the duty of prudence requires that the fiduciary exercise skill, care and caution. As it relates to investments, and specifically ERISA, the duty of prudence usually refers to investing with the right level of risk (or caution). Even more specifically, it involves the fees and costs involved in specific funds. In Hughes, the petitioners to the Supreme Court argue that the fiduciaries breached their duty of prudence because they failed to offer funds in the defined benefits accounts (here a 403(b) plan) with “reasonable fees.”

It’s possible that the arguments surrounding this case could help define what “reasonable fees” are. You may recall that the portions of the new fiduciary rule that the Department of Labor (DOL) tried to roll out concerning reasonable compensation met with a lot of criticism. There, the DOL provided little guidance as to what constitutes reasonable compensation requiring advisors to carefully walk the line of relying on benchmark standards without breaking antitrust price setting rules.

The discussion in Hughes of what constitutes reasonable fees in the context of the ERISA rules could be highly instructive to advisors and other fiduciaries, if those arguments are heard at the Supreme Court.

[1] For more on Beau’s article, The Case for Fee-based Compensation, visit:

[2] For more on my article, Trends in Investment Management and ERISA Plan Fiduciaries, visit:

[3] For more details on the CNBC article, Who won the zero-fee ETF war? It looks like no one, visit:

These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.

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