At the Inside ETFs Europe Conference in June this year, a question was asked to the Independent View panel about whether investors were aware of the true costs of owning an ETF. The answer, which came from portfolio manager Peter Sleep of 7 Investment Management, was no.
In recent months, the ETF market has witnessed a so-called ‘price war’ between ETF providers, with the likes of Vanguard and Lyxor cutting the price, or total expense ratio (TER), of their ETFs.
However, the TER may not reflect the true cost of an ETF and investors may be paying more than they realise.
The TER, which is sometimes labelled an “all-in fee”, is calculated by dividing the total annual cost of the fund by the fund’s total assets averaged over the year. This typically covers the management and operational costs of an ETF and is largely used as a standard measurement for ETFs.
However, this “all-in fee” does not always include all the fees. There are additional transaction costs, bid/offer, stamp duty and premium or discount levels to take into account. There are also fees, such as the swap fee, stock-lending fees and other opaque fees, which are not always included in the TER.
With the increasing regulatory drive for transparency, these extra charges are now coming under scrutiny.
“There is some confusion around the TER, whether it is an ‘all-in fee’ or if it is just a management fee. It can be poorly defined by some providers,” said MJ Lytle, chief development officer at ETP provider Source. “We use the term ‘management fee’, as this fits with what we feel is the true reflection of the costs included.”
In the drive for transparency, ETFs now come with a fact sheet and a key investor information document (KiiD), which are designed to show investors what’s going on in the fund and what costs are where. However, calculating the true cost of ownership of an ETF is still not straightforward in Europe for the end investor.
Feargal Dempsey, independent ETF consultant and director, said: “The KiiD document has gone a long way to driving transparency in ETFs, but there are still a few gaps in it.”
Dempsey says that the KiiD may, for example, miss the impact of securities-lending revenue— positive towards total cost of ownership (TCO), but negative in terms of the cost/profit of that programme retained by the lending agent and/or fund promoter. Similarly, physical fund rebalancing costs and swap spreads are not usually reflected in the KiiDs, though some promoters are correctly, in his view, insisting on their inclusion. For secondary market investors, the cost of accessing ETFs is not reflected in the KiiD.
There are also variables when assessing TCO.
“Particularly the cost of trading, to get in and out of an ETF via the broker, and this is the bit that is changeable depending on the market. This is the bit that the average investor still doesn’t have full transparency on yet in Europe,” said Eleanor Hope-Bell, head of the UK’s intermediary sales at SSgA.
Dempsey says: “Transparency in ETFs should extend to the metrics of tracking error, performance and TCO.”
The extra costs
Broker costs are one of the first fees investors have to pay. They depend on the broker, but “around £15 seems to be the average, as £15 is a typical retail platform charge,” said Peter Sleep.
“Larger investors may be able to swallow this, but for smaller, retail investors, it could wind up being a hit, making investing in ETFs expensive, especially for those saving a little every month,” he said.
Bid/offer spreads can also be high. “The smaller, less liquid and the more exotic ETFs will often have bigger spreads. However, the spread can vary according to the time of day—Friday evenings are often wider,” added Sleep.
Another variable is whether the underlying market is even open. If you’re based in Europe, it’s best to trade the US when the US market is open after lunch, while Japan is best traded early morning.
Whether ETFs trade at a premium or a discount can also have an impact.