ETFs Are Not Cheaper Than Passive Funds

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).)

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.

“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.