Funds with the highest fees reflect the costs of the strategy, not of the management.
ETF proponents like me can get unbearably smug when bragging about the low costs of ETFs. Like all good boasts, there’s truth in it: ETFs excel at delivering big broad portfolios at tiny all-in costs, with tax efficiency to boot.
But with more than 1,650 ETFs on the market and counting, many funds range far beyond the confines of plain-vanilla U.S. equities, where the cheapest funds can be found. At the extreme, the headline fees for some of the more exotic ETFs can be eye-popping.
The chart below comes from our ETF finder. It’s simply a list of 10 of the most expensive ETFs, sorted by expense ratio from high to low.
|High Fee Reason|
|BIZD||Market Vectors BDC Income||9.17%||Acquired fund Fees|
|AMLP||Alerian MLP||8.56%||Deferred Tax Expense|
|MLPA||Global X MLP||7.67%||Deferred Tax Expense|
|YMLI||Yorkville High Income Infrastructure MLP||6.92%||Deferred Tax Expense|
|MLPJ||Global X Junior MLP||5.11%||Deferred Tax Expense|
|YMLP||Yorkville High Income MLP||4.65%||Deferred Tax Expense|
|AGLS||AdvisorShares Accuvest Global Long Short||4.28%||Short Interest|
|SOYB||Teucrium Soybeans||3.97%||Tiny AUM|
|SIZ||QuantShares U.S. Market Neutral Size||3.81%||Short Interest|
|WEAT||Teucrium Wheat||3.74%||Tiny AUM|
Source: ETF.com 9/30/2014
These fees are roughly 100 times more than the cheapest ETFs. Are the issuers of these ETFs really pocketing fees that are 100 times more than those of the cheapest funds?
Not exactly. The largest component of the high fees below typically reflects a set of costs directly associated with running the strategy, rather than managers’ fees.
Russian Dolls (Acquired Fund Fees)
The drivers of the fees in the top 10 fall into four groups.
The first of these are the acquired fund fees that apply to the Market Vectors BDC Income ETF (BIZD | D-99). The fund holds publicly traded business development companies (BDCs)—firms that invest in other companies at the capital structure level. The BDCs themselves can be thought of as investment vehicles with their own expenses.
BIZD, as required by the Securities and Exchange Commission, reports the fees of its BDCs as an expense-ratio line item. The acquired fund expenses aren’t extracted from the net asset value (NAV) by BIZD’s managers; instead they are reflected in the performance of each holding.
Do the BDCs’ expenses affect the performance of BIZD shares? Yes. This highlights an important fact that applies throughout this entire discussion: The performance record of BIZD is net of these fees.
Note that acquired fund fees aren’t confined to BDCs: They often turn up in less dramatic fashion in ETFs that hold other ETFs.