Fees and Performance

This is where things start to get tricky. Since ETFs all track the same index, shouldn’t you just go for the fund with the lowest fee? 

Well, if you look at the performance column on the right of the table you’ll notice that there’s a pretty surprising spread of returns from these ETFs, both amongst funds which distribute dividends and those which capitalise them, and this spread is many times the difference in fees between the various trackers.

For reference, over the first three quarters of 2009 the return from the DJ Euro Stoxx 50 price index was 17.18%, while the total return index gave 20.95%.

The dividend-paying ETFs make their distributions at different times of year and with varying frequency, making a like-for-like comparison between funds difficult, so it helps if we focus on the ETFs which capitalise dividends. There we see that the funds’ returns over the same three quarter period ranged from 21.17% to 23.13%. So how did all the “index-tracking” funds outperform the total return index?

First, there’s a simple tax difference between funds and benchmark: the total return index assumes that dividends are paid out net of withholding tax, while ETF providers are typically able to receive the dividends gross and pass some of the extra return on to funds in the form of “enhancements”. 

Another form of enhancement occurs when ETFs that own the underlying index securities lend them out and pass some of the earned income on to fund holders.

Still, there’s quite a surprising divergence between the returns of the various DJ Euro Stoxx 50 ETFs, which would probably lead an investor to ask further questions about why there is underperformance or why a fund is returning more than its benchmark – substantially more in some cases. After all, most providers state in their description of an ETF’s objectives that it is designed to replicate an index as closely as possible.

Trading Costs

Forming a pan-European view of Euro Stoxx 50 ETF trading liquidity is also not straightforward. One way is to focus on each ETF’s primary listing, as that is where most trading is concentrated, in order to compare funds on a like-for-like basis.

Spotlight on ETF Construction, an iShares publication released earlier this year and available on the company’s website, did just this. It compared the average secondary market dealing spreads on the four largest DJ Euro Stoxx 50 ETFs – using the XETRA listings for the two iShares and the db x-trackers ETFs, and the Euronext listing for Lyxor’s ETF – during the second half of 2008, a period of fairly extreme market volatility.

This analysis showed that the spreads for the ETFs offered by the leading issuers were pretty similar, ranging from 12 basis points for the Lyxor and db x-trackers funds to 14 and 16 basis points for the iShares and iShares (DE) funds, respectively.

The major exchanges also publish data on ETF secondary market spreads, although an investor needs to bear in mind that an ETF might have a more liquid listing in another European market (for an example of this, take a look at the changes in the positions of the Lyxor and db x-trackers ETFs in the liquidity rankings below when comparing the Frankfurt and Paris listings).

XETRA’s latest (Q2) ETF “facts and figures” report gives the following average spread data (in basis points) for the different DJ Euro Stoxx 50 listings on the exchange during June 2009, given in order of widening spreads/decreasing liquidity: Comstage (5bp), ETFlab (8bp), db x-trackers (9bp), iShares (DE) (9bp), iShares (9bp), Lyxor (10bp), Source (13bp), UBS (42bp).

In comparison, the average dealing spreads in July for the DJ Euro Stoxx 50 ETFs listed on NYSE Euronext Paris were, also given in order of widening spreads/decreasing liquidity: CASAM (5bp), Lyxor (6bp), iShares (8bp), EasyETF (9bp), db x-trackers (14bp) and UBS (41bp).

One European market maker told IndexUniverse.eu earlier today that the majority of European Dow Jones Euro Stoxx 50 ETFs were trading “on-screen” with a dealing spread of around 7-8 basis points, which is consistent with these figures. If you’re a large institution you may be able to deal at tighter spreads, but for most investors this will be an acceptable cost of trading.

Conclusion

An investor looking for an ETF tracking the most widely used European equity benchmark needs to take into account various factors – from fund structure, fund size and dividend treatment to cost, performance and secondary market liquidity – when making an informed decision. Who said ETFs were simple?

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