A major event happened in the ETF space last week. State Street drastically lowered the expense ratio on 15 of its core products, to the point where its rebranded SPDR Portfolio funds are competitive again, after years of anemic inflows. SSGA partnered with TD Ameritrade to push its revamped funds onto TD’s no-transaction-fee platform.
TD Ameritrade upped the ante by removing dozens of similar iShares and Vanguard products from its no-transaction-fee platform—slapping a fee on something that had been free. Advisors who had built their businesses around the old offering set are losing their minds.
The price tag that comes with fund expenses and trading commissions is highly visible. We all know that free is best, cheap is next and expensive is toxic. But sometimes what everyone knows doesn’t tell the whole story. The relaunch of the SPDR Portfolio suite might just be one of those times—a moment when ETF due diligence matters.
Beyond Expense Ratios
ETF costs do not end with the expense ratio. Even for ETFs with high asset bases, decent trading volumes and broad, vanilla exposure, investors have to contend with tracking difference and trading costs. When investors or their advisors ignore these, someone is bound to pay the price.
Costs have two main components: tracking difference—which is the performance gap between the fund and its underlying index—and trading costs. The relative importance of each depends on the length of the holding period. Long-term buy-and-hold investors should pay close attention to tracking difference; frequent traders can afford to downplay tracking difference in favor of spreads and market impact.
We can hone in on the effects of tracking difference and trading costs when we look at seven sets of ETFs from competing issuers that track identical indexes. This accounts for half of the SSGA revamped funds. (Well, almost. In November, SSGA will be dropping the Russell 1000, 2000 and 3000 in favor of homegrown indexes. The new indexes should be extraordinarily similar.)
The nice thing about looking at ETFs that offer identical index exposure is that we can focus on pure operational due diligence—costs and risks that arise from fund management and on the trading floor. Costs can eat away at returns; risks can do far worse. There’s nothing like a flat-out loss, such as an exchange-traded note default, for making an investor feel burned. Nobody likes it when issuers close a fund they hold, either. Since none of these direct competitors harbors any blowout risk, we can look to cost as the key differentiator.
Most investors have to watch both tracking difference and trading costs. FactSet ETF Analytics has designed a total cost of ownership metric (TACO) that combines the two, using a one-year holding period. It’s quite instructive to compare the TACO with the expense ratio. The TACO calculations below use restated median tracking difference results to account for the recent expense ratio changes, and median daily average spreads. Here’s what TACO versus expense ratio looks like for the seven sets of direct competitors, as of October 20, 2017:
For a larger view, please click on the image above.
SSGA’s new rock-bottom expense ratios make it the cost leader (or tied) in each of these seven matchups. But SSGA wins on TACO in four cases, leaving the other three to BlackRock and Vanguard. Frequent traders, you’ve been warned.