Costs fall as rivalry grows - but TERs still have a long way to go
Total expense ratios (TERs) for exchange traded funds (ETFs) in Europe have declined over the past year as increasing competition among providers has helped drive costs down.
According to the latest research by ETFGI, the overall average TER for ETFs in Europe is now 36 basis points (bps) down from 37bps in January 2011.
TERs for ETFs listed in Europe are still higher than the TERs for ETFs listed in the US where the overall average is 29bps, down from 32bps in January 2011.
The move to lower fees has in part been fuelled by price competition among many of the ETF managers. A number of managers have stated part of their sales strategy is to be a low cost provider of ETFs where TER is the factor most commonly used to measure the annual cost of owning a fund or ETF.
For some ETF managers, the TERs on their ETFs will decline as the fund grows and passes certain thresholds in assets under management.
Fees: Europe versus the US
Fund size is one factor that can help to explain why fees are higher in Europe compared to the US. More than 40% of ETFs in Europe have assets under $25 million (£15 million) compared to 36% of funds in the US.
Among the reason for the average fund size in Europe being smaller than in the US is that America tends to have one or two ETFs on the same benchmark, while in Europe there tends to be a much greater number of ETFs covering the same benchmark.
One example is the proliferation in similar products tracking the Euro Stoxx 50 index, with 46 Euro Stoxx 50 ETFs, 199 listings and only $22.1 billion invested across all of these.
Many investors focus just on the TER as the cost of investing in a fund or ETF. The TER is the ratio of the fund’s total operating costs to its average net assets.
The calculation of this ratio will, broadly, include management fees, administration and distribution costs but typically excludes transaction costs, payments through use of derivatives, entry and exit commissions or other fees paid directly by the investor.
In physically backed funds the impact of rebalancing will not be reflected in the TER, while in synthetic funds the swap transaction costs are similarly not covered in the TER.
In both physical and synthetic funds, the secondary market investor needs to consider the commission and spread charged by their broker.
Muddy waters
As ever when we consider non-fund exchange traded exposures, such as exchange traded notes and exchange traded commodities or currencies, we are in significantly less clear territory and there is no requirement to publish a TER.
While the prospectus of these instruments will require full fee disclosure, the experience of the retail investor trying to decipher a prospectus – which may be unseen by the secondary market investor – often requires reading and interpreting formulas on how various fees are calculated.
Investors should remember that TER is only one of the costs of owning a fund or ETF. When comparing the total cost of ownership the TER is just one component. Transaction costs, spreads, tax and distribution fees, entry and exit costs are some of the other costs that should be considered when comparing ETFs and funds.
Meaningful analysis of funds can only be through a like-for-like analysis based on cost and performance and it is important that investors – and in particular the retail investor – have sufficient weapons at their disposal to facilitate this.