Jan 29 - Price competition among providers of mutual funds and exchange-traded funds (ETFs) is likely to put pressure on investment management fee growth for U.S. trust and custodial banks, according to Fitch Ratings. Recent moves by Fidelity, Vanguard, Schwab, Blackrock, and other fund managers to reduce index fund and ETF fees paid by increasingly cost-conscious investors will make it difficult for trust banks, such as State Street, Northern Trust, and Bank of New York Mellon, to push through meaningful fee growth on individual and institutional customer accounts. While the major U.S. trust banks all reported investment management and servicing fee growth in 4Q12 as a result of stronger equity markets and some new business, they have been forced to adjust pricing strategies in ways that may erode profitability of this core business that touches multiple revenue streams, particularly if trading volumes and investment inflows remain weak. This price competition is particularly relevant in the plain vanilla index space, which serves to replicate investment returns of bellwether indices such as the S&P 500 and Dow Jones Industrial Average, among others. As a result, some of the larger asset managers and trust banks are launching more niche ETF and index products in areas such as commodities and emerging markets. These newer products have the benefit of capturing the strong demand in the marketplace for more index-like products, providing clients with exposure to less developed and higher growth sectors. They also carry higher management fees than the more traditional products noted above. Since the financial crisis, net outflows from actively managed funds into index products and ETFs have made it more difficult for managers of higher cost products to compete. The growth of ETFs, with low expenses and no restrictions on trading throughout the day, is posing a threat to actively managed funds in both the retail and institutional channels. Furthermore, we think that a race to the bottom in fees for index funds and ETFs likely signals the growing importance of scale in the asset management business, with slow fee growth and lower margins discouraging market entry by competitors. In a more mature industry, with consolidation largely complete, smaller competitors in the index fund and ETF space will find it increasingly difficult to challenge incumbents, while future price competition from the existing large incumbents is likely. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.