The passive funds and ETFs that pay investors to invest  

Across the pond, some index tracker firms have moved to zero or negative fees. We explain how this works and why this type of fee structure is unlikely to arrive in the UK anytime soon.

Over the past few years, providers of index tracking funds and exchange-traded funds (ETFs) have been engaged in a price war, sending fees to record low levels.

However, the race to the bottom seems to have entered new territory, with some passive products sold to US investors now offering both a zero fee and negative fees.

Last year, Fidelity launched two index funds charging zero fees – the first in history. More recently, US company Salt Financial filed its so called “negative fee” ETF with the authorities in the US. The ETF, called Salt Low TruBeta US Market ETF (listed on the NYSE), has a temporary negative fee of 0.05%. That is, it will pay investors 0.05% of their investment.

What’s the catch?

The key point about either zero or negative fee products is that they are, by and large, a marketing tool.

The idea behind Fidelity’s zero fee index fund is to get investors “into the shop.” The zero cost funds are only available on Fidelity’s own platform. Therefore, investors interested in the zero fee index fund, the asset management firm hopes, will join their platform (for which there is a fee). After that, Fidelity hopes, they end up buying other products on the platform that do charge a fee.

At the same time, companies like Fidelity can attempt to cover some of the losses from zero fee products by lending the stocks it holds to short sellers.

From the investors perspective, the only real risk with Fidelity’s zero fee index fund is that it encourages them to join the Fidelity platform when it is not necessarily suitable for them to do so. Each platform has its own fee structure – the most suitable one depends on the size of an investor’s pot and types of investments they buy.  

When it comes to Salt Financials ETF, the catch is a little more complicated. As mentioned, the negative fee is 0.05% - but only for a limited time. The negative fee will only apply to the first £100 million invested in the ETF and will apply only until April 2020. After, the fee will revert to 0.29%, which is a fairly standard amount for an ETF.

Behind Salt Financial’s temporary negative fee is an attempt to grow quickly in an already crowded market. It is no coincidence that ETFs are generally considered to need to have at least £100 million in assets to viable – the amount the negative fee applies until. The negative fee is an attempt to allow the ETF to scale up quick enough to reach that viable stage.

As long as investors are aware that the fee is temporary, this should not matter. Even then, the new charge is broadly in line with what most ETFs of similar nature charge. However, it is worth noting that a negative fee of 0.05% will not see an investor earn much money. A holding of £10,000 would see an investor awarded £5. £100,000 would earn an investor £50.

Will they be coming to the UK?

Unfortunately for fee conscious investors, neither product is available in the UK. Fidelity’s zero cost index funds are only available to users of its US platform. Meanwhile, Salt Financial’s ETF is launching only in the US.  

However, if the trend for zero cost or negative fee products is catching on in the US, surely the UK will soon follow behind?

Not according to Adam Laird head of ETF Strategy for Northern Europe at Lyxor, the ETF provider. The key issue, says Laird, is the difference in regulation between the UK and the US.

“Regulators from the Financial Conduct Authority and Europe more broadly have put more focus on transparency. They mood is that you can only earn money off the fund fee,” he notes.

This means that lending stock held in zero cost or negative cost funds or ETFs is not a possibility. “In America, you can lend stock. In the UK, you are allowed to lend but have to give profit back to the investor,” he says. That takes away an easy method of subsidising zero cost or negative fee products.

At the same time, Laird sees the culture of investors as different. In reference to Lyxor’s own products, he notes: “Investors are always asking ‘how are you paying for this, what is the economics.’ I don’t believe investors would stand for something that looks too good to be true.”

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Comments

Do funds and trusts sold in Europe lend to short sellers?

The article mentions that US ETFs can lend to short sellers, does this happen in Europe too? Isn't this against the interests of investors in the short term, especially anyone who is considering selling their ETF soon?

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