Uncovering Cheap And Even Cheaper ETFs

When we noted for the record that the MSCI All Country World Index had climbed to a record, we described how, lately, the outsized returns were coming from international stocks in a reversion to the mean following the dominance of U.S. stocks. This analysis led to an interesting revelation that sometimes the cheapest-seeming option isn't the cheapest option after all.

First, we pointed out that if you want a broad index-based approach to a global stock allocation, two funds loom large: the iShares MSCI ACWI Index Fund (ACWI | A-96) and the Vanguard Total World Stock ETF (VT | A-100). ACWI comes with an annual expense ratio of 34 basis points, or $34 for each $10,000 invested. VT, true to Vanguard’s reputation as a low-cost purveyor, comes in at 17 basis points.

Both ETFs, by the way, can be bought and sold commission-free: ACWI on Fidelity’s platform and VT on Vanguard’s platform—another sign of how cheap owning ETFs can be.

That’s Not The Half Of It

Regarding inexpensive ETFs and the MSCI ACWI Index, consider that investors can obtain the equivalent exposure to either iShares’ ACWI or Vanguard’s VT by owning two separate pairs of ETFs sponsored by both companies. They are:

• First, you can obtain ACWI exposure by owning the iShares Core S&P Total U.S. Stock Market ETF (ITOT | A-100) and the iShares Core MSCI Total International Stock ETF (IXUS | A-99).
• At Vanguard, you can get the equivalent of VT by owning both the Vanguard Total Stock Market ETF (VTI | A-100) for U.S. stocks and the Vanguard Total International Stock ETF (VXUS | A-99).

Charts Courtesy of StockCharts.com

These two, broadly similar charts clearly suggest that whether you favor Vanguard or iShares products, the results of using either U.S.-international pair to get global exposure basically gets you the same returns as owning either of the total global funds, ACWI or VT.

Again, the MSCI ACWI Index reached a record last week—Feb. 25, specifically. To dissect that record, it’s worth pointing out that the U.S. index underlying the U.S.-focused fund ITOT, the S&P Composite 1500, actually hit an all-time record on March 2, 2015, according to data posted on iShares’ website. The MSCI ACWI ex USA IMI Index on which the international fund IXUS is built is below a record it hit in July 2014.

Drilling Down Into Pricing

If you look more closely at the prices of these funds, things gets very interesting.

iShares’ ACWI, as I noted above, has an annual expense ratio of 34 basis points. But by combining ITOT and IXUS to recreate ACWI—which is to say global equities exposure of about 52 percent U.S. via ITOT, plus about 48 percent international allocation via IXUS creates a combined expense ratio of just north of 10 basis points. (ITOT has a 7 basis point expense ratio and IXUS costs 14 basis points a year.)

That’s less than a third of the ACWI’s expense ratio, though, crucially, ACWI’s 34-basis-point expense is not the all-in cost of owning this ETF. (That’s a subject for another day that deserves its own blog.)

In the Vanguard case, VT’s annual expense ratio of 17 basis points ends up being more than the blended expense ratio of a VTI + VXUS combo, which comes in at about 9.33 basis points a year, or about $9.33 a year for each $10,000 invested. (VTI has a 5 basis point expense ratio while VXUS costs 14 basis points.)

The Reasons

Uncovering these kinds of cost savings is one of the delights of the ETF space. Who knew the constituent pieces of these two big global equities funds—ACWI and VT—would be cheaper than the big funds themselves. And why is that?

The explanation for the lower blended expense ratio of the blended Vanguard ETFs will be familiar to anyone who is familiar with Vanguard. Expense ratios there are driven by assets—as in, the more the assets, the lower the fees.

So, the bottom line is this: The portfolios of which VTI and VXUS are a part are much bigger than the broader portfolio of which VT is a part.

iShares, the wholly owned unit of the publicly traded BlackRock Inc., is of course a very different company than Vanguard.

The ‘Core’ ETFs

In the case of the iShares products, the lower blended expense ratio of the ITOT + IXUS combination is all about the “Core” moniker in the name of each of the funds.

The Core ETFs, rolled out in October 2012, in part to compete more effectively with the likes of Vanguard, are some of the cheapest ETFs on the market and, in this example, it shows.

By the way, ITOT and IXUS—like ACWI—are also available commission-free on Fidelity’s platform under the agreement between Fidelity and iShares that makes almost 80 iShares ETFs commission-free.

The takeaway is this: The ETF world is full of surprises when it comes to low costs and, as I said above regarding ACWI, there’s more to uncover beyond its expense ratio. So stay tuned.

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