ETFs Are Not Cheaper Than Passive Funds

If you only include clean share classes on passive funds, Defaqto finds ETFs are more expensive  

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Editor, etf.com Europe
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Reviewed by: Rachael Revesz
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Edited by: Rachael Revesz

Exchange traded funds (ETFs) are more expensive than traditional index tracking funds - if you only take so-called “clean” share classes on passive trackers into account, according to new research.

Ratings and consultancy shop Defaqto said in its latest newsletter for financial advisers that ETFs usually come out best when comparing passive fund costs due to the legacy commission loaded into certain share classes of index tracking funds, which were widely available before the Retail Distribution Review (RDR).

The RDR was implemented in January 2013 and banned advisers from selling products and funds for commission, and only “legacy” commission payments were allowed to continue in some cases. Now, stripping out these “dirty” share classes from passive trackers, the costs of "clean" passive trackers versus ETFs are displayed below (by asset class, as measured by their ongoing charge figure (OCF).)

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In most cases, passive trackers are significantly cheaper than ETFs. For example, in emerging markets equity, the average ETF OCF is over 0.6 percent, while for a passive fund it is below 0.5 percent.

“It is also important, however, to consider other costs involved with both types of investment vehicle,” the report read.

Defaqto again measured tracking difference of ETFs versus index funds on each asset class, using R-squared, whereby a figure of 100 means that the fund’s returns are 100 percent correlated with the benchmark.

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“In conclusion, although OCFs are lower on average for clean share classes of passive funds when compared with ETFs, we have seen that there can be a trade off in that ETFs can offer better tracking potential on average," read the Defaqto report.

 

Rachael Revesz joined etf.com in August 2013 as staff writer. Previously an investment reporter at Citywire, she has a background in writing content for retail financial advisors and has covered a wide range of subjects in finance. Revesz studied journalism at PMA Media, which has since merged with the Press Association. She also holds a B.A. in modern languages from Durham University, as well as CF1 and CF2 financial planning certificates from the CII.