Last week saw Hector McNeil, co-CEO of HANetf publish a note on zero fee ETFs, dismissing them as a gimmick that should be avoided.
Fees have been falling on ETFs over the last few years globally. Within Europe, Lyxor’s ultra-low-cost ETF range is at 0.04 per cent, while Amundi’s recent global ETFs in equities and fixed income have a 0.05 per cent fee base.
In the US, fees have been slashed to negative. The ETF provider is effectively paying the investor to invest with them. Allan Lane, founding partner, Algo-Chain, says: “The war on ETF management fees has been going on now for over 10 years and shows no sign of abating. In the US SALT Financial, a new entrant to the ETF markets, aims to launch an ETF that looks to pay its investors five basis points for holding the fund, which does suggest we are entering a whole new era.”
The negative fee SALT TruBeta ETF costs -5pbs until the assets under management get to USD100 million, whereupon the fee will become 29bps.
Lane warns that this trend for lower fees, is often misinterpreted as a battle between active and passive investing. “In reality it is a by-product of the fund management industry undergoing its own phase of digital disruption. Until all unjustified costs are shaken out of the system, expect the war on fees to continue,” he says.
Oliver Smith, Portfolio Manager at IG, which has about 13 per cent of assets under administration in ETFs these days (up from 2 per cent four years ago) says that reducing fees to zero or even lower seems to be an effective way of grabbing short term headlines.
“It’s a stunt that can work in the US with a large audience trading on the same exchange but in Europe costs are much higher for ETF providers and that will prohibit a zero per cent fee.”
It is the famed fragmentation of the European ETF market that leads to higher costs, with European ETF providers having to pay issuance costs across a number of exchanges.
McNeil comments that the European market is quite different from the US market, where passives have taken a much larger market share, and he thinks it unlikely zero-fee products, would be well-received in Europe. “It will be harder for this to take root in Europe because it is more competitive here,” he says. “With far more indices to monitor and focus on. The audience is also far less ‘retail’ than the US.”
From the European buy-side perspective, Alan Miller (pictured), Founding Partner, Chief Investment Officer, SCM Group, comments: “I am interested in why there is so much criticism of zero fee ETFs. It’s up to the manufacturers what they charge and the buyers whether they want to buy it.”
Miller points out that it takes a long time for an ETF priced at 0.04 per cent to seem hugely more expensive than one priced at 0 per cent.
IG’s Smith agrees: “It will it take a long time in terms of years of compounding to see a difference in the two returns between a low fee and zero fee.”
For former hedge fund manager Miller, who now exclusively uses ETFs in his portfolios, it’s all about actively investing in passives. “We choose the asset first and the most efficient ETF second,” he says.
Lyxor’s Adam Laird, head of ETF strategy, Northern Europe, comments: “The zero fees proposition is very much a US phenomenon and not something that has hit Europe and with the regulatory landscape we are in it’s very unlikely that we will get right down to zero.”
Laird points out that everyone knows there is no such thing as a free lunch: “If headline fees are zero then the returns are being garnered somewhere else,” he says.
“Within Europe, we have been so focused on transparency and disclosure that it’s inconceivable somebody could subsidise their product and come out with that zero level.”
When Lyxor launched its ultra-low-cost range, the market asked if it would completely cut out fees. “But our core range is physical with no securities lending because investors didn’t want to compromise on quality with their low-cost investments,” Laird says.
Back on the buy-side, Shaun Port, digital portfolio management firm Nutmeg’s CIO says: “I don’t think we’ll zero fee ETFs any time soon, but we will see a super low fee ETF, with fees of one or two bps.”
Port sees this as a natural transition from the core equity ETFs based on MSCI or FTSE indices where the ETF provider is paying for the intellectual property to cheaper and not so well-known index providers.
“I can see a low core equity fund at one or two basis points bearing in mind that ETF providers get a share of the revenue from securities lending, which can be substantial,” Port says.
“One of the biggest costs of running an ETF is the index fee and cutting it to virtually nothing and adding in securities lending creates a potential for very low fees.”
Port forecasts core expensive products such as emerging market debt or high yield which currently cost 40, 50 or 60 bps, reducing to 15 or 20 bps. “A provider that comes out with something like that will see a big shift in volume,” he says.
