Highest Fee ETFs—Where The Money Goes

October 02, 2014

A Tax Middleman (Deferred Tax Expenses)

Funds like the massive Alerian MLP ETF (AMLP) report high fees due to their unique legal structure. As a C-corporation, AMLP is taxed at the fund level, unlike most ETFs. In short, the underlying portfolio of master limited partnerships is marked to market daily, and taxes on gains are accounted for on an ongoing basis. The fund is required to state the tax for the previous 12 months on its prospectus.

As with the BDC example, the deferred tax expense reflects the cost of running the strategy—accessing MLPs in a C-corp wrapper. And the cost also shows up in the daily share performance of AMLP. Taxes on gains at the fund level ultimately go to the government, not to the ETF issuer.

Borrowed Time (Short Interest Expense)

Taking short positions costs money. The AdvisorShares Accuvest Global Long Short ETF (AGLS | F-39) bets in part that stocks in certain regions will fall rather than rise. The short interest is the cost to borrow the securities (which are then sold) and to maintain a margin account. Again, it’s the execution of the strategy that costs money. Short-interest expense definitely impacts the bottom line, but it’s not a fee collected by managers.

The Wallflower Effect (Tiny AUM)

The high headline fee of the Teucrium Soybeans ETF (SOYB | 11) differs from the other three types of costs I mentioned. It results from a combination of the accounting associated with its legal structure and its lack of popularity.

As a commodities pool, the SOYB prospectus states its expenses as a breakeven amount. The largest component is the ratio of the fixed costs of running the fund in dollars, divided by assets under management. The fund is tiny by ETF standards, with just $4 million in assets, which drives the breakeven figure skyward.

The difference here versus the other high-cost drivers is that SOYB’s high fee would go away if the fund were more popular. (SOYB’s sister fund, the Teucrium Wheat ETF (WEAT | F-100)) has a high fee that will likely drop due to sizable inflows since fund documents were last published.) That’s not the case for funds like BDC, AMLP and AGLS, whose high headline fees aren’t driven by assets under management.

With the exception of the unpopularity problem SOYB has, the high fees here reflect costs you’d bear if you tried to execute the strategy on your own. The simple takeaway is to have high conviction if you want to invest in an expensive strategy, because the ETFs that deliver these strategies faithfully pass on their expenses.

At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.

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