Nadig: Going Beyond Cheap

December 01, 2017

[This article appears in our December issue of ETF Report.]

This issue of ETFR catalogs a lot of the “Sturm und Drang” of 2017. The rash of launches. The niche products that managed to gain traction. The rise of ESG and active management.

But oddly, I find it doesn’t actually capture what’s really been happening over the last 12 months as well as this statistic from our annual advisor survey: When asked what matters in ETF selection, 64% of respondents said expense ratio was a very important issue (as opposed to “somewhat important” or “not important”), beating out index methodology and even performance.

Digging under the hood reveals a few other interesting tidbits: 53% of advisors said the primary reason they focus on cost is because they have a fiduciary obligation to their clients. When asked about actively managed funds, 67% of advisors said expense ratio was very important—while only 63% said performance history was.

The response from the industry doesn’t necessarily show up in the launches—it shows up in the escalating fee war among established players. 2017 was full of these stories. In October, State Street Global Advisors cut fees on over 15 funds, and not just a little: the SPDR Portfolio Emerging Markets ETF (SPEM) was slashed from 0.59% to 0.11%. The SPDR Portfolio S&P 500 Growth and Value ETFs (SPYG, SPYV) were slashed from 0.15% to 0.04%.

Wave Of Cheap
These cuts from SSGA were part of a “wave of cheap” that’s swept the ETF landscape over the past few years, led in part by the entry of Schwab in 2009, which rocked the market with a whole lineup of funds at Vanguard-beating fees.

The latest salvo has come from relative ETF newcomer, Franklin Templeton, which launched a full suite of country funds covering everything from the exotic (Brazil, at 0.19%) to the more mundane (Japan, at 0.09%).

Beyond Expense Ratio?
But I’d sound one note of caution. There is more to investing than simply picking the cheapest possible fund. Managing any portfolio—no matter how cheap or passive— actually requires both operational chops and some level of organizational skill. Whether that’s running a good securities lending program, effectively handling corporate actions, or having an aggressive tax-recapture program for international securities, there are nuances to passive management that show up in real performance.

You can see those differences in a single statistic: median tracking difference, which is simply how far behind the tracked index you are in any given 12 months. You’d expect to trail by the expense ratio, but in fact, you often do a bit better, or a bit worse.

Investors may find some surprises. Schwab’s U.S. Small-Cap ETF (SCHA), for instance, is the segment’s lowest in terms of cost, at 0.05%, and it performs even better, actually earning back 6 basis points (likely through securities lending) to beat its own index by a basis point. But the comparatively expensive Vanguard S&P Small-Cap 600 ETF (VIOO), at a cost of 0.15%, actually outperforms its own index by 0.06%—a whopping 21 basis points of consistent outperformance.

That doesn’t make Vanguard the guaranteed winner or Schwab the loser—lower costs are always more predictable than tracking difference—but it proves the point: There is always, always more to cost than meets the eye.


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