Here’s why you should check the small print on ETF charges

Research highlights why passive investors should look beyond the headline annual

Over the past couple of years more and more investors have been choosing to go down the passive route. 

According to the Investment Association (IA), retail investors hold £162 billion in tracker funds – 13.6 per cent of the total invested. In contrast, in the summer of 2007, before the financial crisis struck, the amount held in trackers was a mere £29 billion, which at the time represented 6.3 per cent of the total. 

There are various factors at play behind the passive boom, but one of the biggest drivers has been the price war that has broken out amongst some of the big players in the space, which has driven down passive fund fees to record lows.  

Investors can now track the S&P 500 index for as little as 0.04 per cent. In the past charges were on the whole much lower than active funds, but not as cheap as chips. According to Morningstar the typical US passive fund charge stood at 0.25 per cent a decade ago. 

Although low costs and simplicity are two attractions that ETFs have in their favour, it is important to look under the bonnet, as evidenced by research carried out by Fitz Partners. The firm points out that it is well worth remembering that just as in the case of active funds, the ongoing charge figure (OCF) displayed on ETF funds does not include transaction fees.

The research found some hyperactive ETFs have a yearly fund transaction fee that is five times higher than the quoted OCF. This makes some smart beta passive funds more expensive than active funds, adds Fitz Partners. 

Overall, though, Fitz Partners says if trading costs were included inside the headline OCF charge, those charges would increase on average by 21 per cent for an active equity fund, 29 per cent for index trackers and 26 per cent for ETFs.

Hugues Gillibert, chief executive of Fitz Partners, says: ‘Adding 20 basis points (0.2 per cent) of trading fees to an OCF of 1 per cent is not really welcome, but certainly not as impactful as adding the same 20bps to a lower OCF of say 0.25 per cent. In the last few years, most funds including ETFs have been lowering their OCFs quoted to investors. With the implementation of MiFID II (new regulations coming into force at the start of 2018), trading costs will become more transparent and allow investors to refine their investment choice.’ 

-Fixed income ETFs don’t deliver

Why it's crucial to look carefully at charges on trackers

The aim of every investor should be to cut their costs to the absolute minimum, while seeking out the fund managers who are most likely to outperform the market.

But when it comes to tracker funds, do not make the mistake of thinking they are all cheap.

Tracker funds can cost less than 0.1 per cent a year, but some charge 10 times this amount. For example, the Virgin UK Index Tracking fund, which holds £2.8 billion in assets, costs an expensive 1 per cent.

The higher the charge, the more handicapped each tracker is in trying to keep pace with the index it is blindly following.

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