Don’t Choose An ETF Based On Fees Alone

May 01, 2017

Todd Rosenbluth is director of ETF and mutual fund research at CFRA.

A purveyor of fine wine or well-aged cheeses can justify a premium from the market, but investors are regularly on the prowl for the lowest-cost product. Sometimes, cheaper is not better.

Last week, Vanguard continued its tradition of lowering the expense ratio of its index-based mutual funds and ETFs with the fee reduction of several dozen equity, fixed-income and asset allocation funds across various share classes. Vanguard also reported one portfolio had a fee increase. You can see all the details here.

CFRA expects the variety of lower-cost passive products will further cause investors and advisors to shift money away from actively managed funds, in light of the performance challenges. In the three-year period ended 2016, just 7% of active large-cap mutual funds outperformed the S&P 500 Index.

Investing Goals More Easily Achieved

Overall, fee compression is worth applauding, as the more money being put to work in investor portfolios will help them better achieve their long-term goals.

For example, Vanguard trimming the fee for its S&P 500 Index products—the Vanguard 500 Index Admiral class (VFIAX) and Vanguard 500 Index ETF (VOO)—by 1 basis point to 0.04% will enable shareholders to better replicate the performance of the large-cap index.

While VFIAX is 1 basis point more expensive than the Schwab S&P 500 Index (SWPPX), VOO’s fee matches the iShares S&P 500 (IVV), and will help Vanguard narrow the minor potential performance gap between its offerings and competing products. They all hold the same large-cap securities at the same weighting, and management does a similarly strong job tracking the index.

Where Lower Fees Are Not As Meaningful

However, most of the other fee cuts took place in ETFs and mutual funds that aren’t really matched by their passive peers.

For example, the expense ratio for the Vanguard FTSE Developed Markets ETF (VEA) fell by 2 basis points to 0.07%. This makes VEA 1 basis point cheaper than the iShares Core MSCI EAFE Index (IEFA). However, IEFA’s 11.2% year-to-date gain through April 27 was ahead of VEA’s 10.4%, as performance is driven more by holdings than fees. VEA has exposure to Canada (8% of assets) not found in IEFA, and it has a lower stake in France and Germany.

Low-Cost Developed Int'l ETFs Are Not Identical

Source: CFRA Research’s MarketScope Advisor, April 27, 2017



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