ETF fees are fairly permanently in the spotlight and the current price war between providers means that fees appear to continue to be pushed down.
Allan Lane, Founding Partner, Algo-Chain says: “The topic of lower fees remains the most vexing question of the day. Without a doubt, lower will attract more assets, but in the long run the piper does need paying. There’s no turning back, lower fees, or even zero fees are here to stay. What this means though, is that across the value chain it will be a case of musical chairs as brokers step in and try to do more in the model portfolio space.”
Last year saw HANetf’s Hector McNeil putting pen to paper, decrying the zero-fee ETF as: ‘simply a gimmick and should be avoided’.
Mark Fitzgerald, Head of Product Specialism, Vanguard, Europe is also not keen on the fee waivered ETF. “We think that no fee ETFs are gimmicky to the extent that you don’t get something for nothing. We are not going to say we will give you something for free because someone has to pay or there is some other fee levied that enables you to access the ETF.”
In this paper, McNeil wrote: “Passive providers have increasingly cut prices in a bid to undercut each over the past few years with ETFs in the UK carrying fees of well below 10 basis points as the norm. Additionally, last year we saw the launch of a zero-fee index fund in the US as providers race to the bottom on charges.
“However, while they may initially seem appealing, ETFs with no charges will actually put the investor at a disadvantage.”
McNeil says: “It’s worth remembering zero fund fees are a misnomer – it’s like when you apply for a mortgage and see all the special offers, but when you look at the small print you see all sorts of clauses.”
Getting people to speak on the subject of zero fee or low fee ETFs is difficult – there is clearly some sensitivity on the subject, but despite any reluctance to speak formally on the subject, low fees are still very much a part of the marketing for new ETF products.
Lyxor recently launched three High Yield ESG ETFs, covering USD High Yield, EUR High Yield, and Global High Yield, using Bloomberg Barclays MSCI Sustainable SRI indices, with the claim that a Total Expense Ratio (TER) of 0.25 per cent makes them ‘the lowest-cost ETFs tracking High Yield indices with ESG filters’.
A recent academic paper, The Dynamics of ETF Fees, casts doubt on the fact that fees have been coming down at all. Academics Travis Box, Ryan Davis and Kathleen Fuller write that despite widely publicised fee reductions, average expense ratios of ETFs remained relatively steady between 2004 and 2018.
The authors write: “Toward the end of 2015, a stream of news coverage began to follow an ongoing contest between several prominent sponsors of ETFs to become the industry’s low-cost leader in fund provision. According to these reports, the real winners in this race to the bottom are individual investors as they reap the rewards of tumbling investment fees. The rapid pace of fund creation, however, suggests that most ETF sponsors are still willing to bring new offerings online despite these competitive pressures. Although fees for certain funds have fallen substantially, we questioned whether such high-profile cuts have affected expenses across the industry. Therefore, we set out to examine how the fees of most ETFs have evolved over the past 15 years.”
Their research revealed that even though thousands of new funds entered the market during this period, the arrival of most ETF sponsors into a narrowly defined area has not generally led to lower fees for competing funds.
“Given the impact of fees on long-term investment returns, investors should carefully examine all available opportunities before choosing specific funds. Furthermore, as objectives for newer ETFs become increasingly specialised, investors must also consider whether the benefits of targeted strategies justify their higher prices.”
The authors comment on the press coverage of low fees and writes: “We were concerned that widely publicised accounts of fund sponsor fee wars do not accurately describe the severity of competition within the ETF industry. Although tremendous deals may be found in some of the most popular investment categories, fee competition among fund providers has not lowered expenses for all ETFs across the industry. Consequently, inattentive investors might inadvertently choose high-priced funds if their perceptions about competitiveness are based on the narrow subset of ETFs covered in the financial press.
“At the end of 2018, 28 ETFs were offering expense ratios of five basis points (bps) or less. Together, these funds covered several broad US fixed-income indexes and provided exposure to the equity markets of most developed economies. Even though these ETFs offer some of the lowest fees in their respective categories, the majority are sponsored by providers whose expense ratios are not significantly lower than those of their competitors for most other fund types. We encourage investors to take full advantage of the headline-grabbing ETFs, but we also caution that popular perceptions are no substitute for diligence when selecting specific investments, especially in the less conventional parts of a portfolio.”
Vanguard is famously owned by its staff, and also for its late founder, Jack Bogle, who regularly argued that the best predictor of investment returns was the amount of fees paid.
Vanguard Europe’s Fitzgerald says: “Jack Bogle wrote the book on low cost investing – actually he wrote about 26 – all saying don’t pay too much for investments.”
Fitzgerald says: “In terms of price compression there has been a levelling off with a big drop in fees over the last 10 years plus but it is important to differentiate between vanilla building block ETFs that have become very competitive and cost effective and the development of different types of strategies and approaches such as ESG, smart beta, quant strategies and some active ETFs. They are not as expensive as they were but they are more than the big liquid building block ETFs that you can get for a few basis points.”
At the end of 2012, Vanguard’s asset weighted ongoing charges figure (OCF) was 15bps and by the end of 2019 that had come down to 10bps. Meanwhile, the simple average went from 20bps to 13bps over the same time period. To put that in context, the asset weighted OCF of the European ETF industry was 25bps at the end 2019.
Going forward, Fitzgerald believes that over time, prices will drop further, come down quite rapidly and get to a natural floor. “Price drops in the future won’t be as dramatic as they haven’t got as far to fall,” he says.
“We want to help the mass investing public by offering competitive products which force our competitors to lower their prices and then everyone benefits.”
Out on the road, talking to wealth managers and IFAs, Fitzgerald is beginning to see a real shift towards ETF usage, with more hands going up in the room whenever he asks: “Who here uses ETFs?”
The UK is a dominant force in the ETF industry in Europe, with half of the current assets in ETFs in Europe coming from the UK, but the traditional adviser in the UK has struggled to access ETFs because the platforms weren’t designed to cope with them, either making it impossible or more expensive to trade ETFs. However, some are now adapting and new ones are launching which allow ETFs to be included in retail portfolios.
In Europe, Vanguard has USD55 billion dollars in ETFs, and globally, over USD1 trillion making them the second largest in the world and the sixth largest in Europe.
The firm tends to focus on a range of fewer than 30 products with different share classes, while the five issuers who rank above them in Europe will tend to have over 100 ETFs. Fitzgerald says that avoiding lots of niche high margin products is part of the firm’s product philosophy and culture across all their businesses, anywhere in the world.
Fitzgerald comments that whether you trade GBP500 or GBP500 million in ETFs, you will pay the same price which makes them a very democratic and transparent route to investing.