Recently Fidelity became the first investment company to offer a line of mutual funds that have a 0% expense ratio. This “race to the bottom” has actually been going on for quite some time. Much of the pressure firms like Fidelity have been feeling has come from the advent of the exchange traded fund, better know as the ETF. The very first ETF was the S&P 500 Trust ETF (SPY) which was debuted on January 22, 1993 by State Street Global Investors. But even before the ETF arrived on the scene, the idea of cutting costs and indexing had been around since the 1970’s. It was Jack Bogle and Vanguard that developed the first passive index mutual fund. Vanguard began operations on May 1, 1975 and it is not a coincidence that on that same day the New York Stock exchange made a major change to how it ran its own operations.
At the New York Stock Exchange, May 1, 1975 is know as “Mayday”. The name was coined by Robert Baldwin who was the chairman at Morgan Stanley at the time. In his younger days he was undersecretary of the navy, and mayday was the distress call that went out when ships were in trouble. When the NYSE was founded in 1792 it put in place a policy of fixed commissions. Every member of the exchange could charge its clients no less than a certain amount. This was designed to prevent people from undercutting each other and to create an orderly market. However, by the 1960’s the DOJ and SEC had made it clear to the NYSE that they were not in favor of the fixed commission regime and in September of 1973 the SEC formally demanded that the policy be changed. There was a tremendous amount of push back from most members of the exchange because fixed commissions made life on Wall Street easy. There was no discounting, no negotiating.
Commissions and the fees that firms charged dropped over night. Many smaller inefficiently run firms who were propped up by the higher commission began to fail and close up shop. The larger better run firms were able to lower the costs to the individual investor and they picked up what revenue they lost in an increase in volume. In a way, Mayday defragmented the brokerage industry and made it much sounder.
Mayday opened the gates for Vanguard and firms alike to start charging its customers less. The explosion in volume since 1975 has enabled these firms to drop their expense ratios to such minimal levels. It is ironic that for over 180 years the symbol of capitalism and free markets (the NYSE) actually ran its own operations like a cartel, disallowing competitive pricing.