At a glance
While the benefits of investing in ETFs are varied, and have been discussed at length, it is worth having a look at some of the numbers, and comparing the difference over time that a low cost ETF can make on an investor’s overall portfolio, when substituting out from a Managed Fund or Listed Investment Company.
Actively managed investments, Managed Funds and LICs will typically charge substantially higher management fees than passively managed ETFs, even when their investment exposures are similar. Investors then have to factor in any performance fees, which some funds charge for outperforming their given index or benchmark. Scrutiny on fees has become even more marked when one considers the statistical record of active managers compared to their benchmarks. As the recently launched SPIVA® report from S&P Dow Jones illustrates, as at end 2017, over, say, a 10 year period, almost three-quarters of active managers benchmarked to the S&P/ASX 200 underperformed that benchmark. As you will see from the exhibit below, the numbers are generally not much better for managers focused on other categories either.
There seems little doubt that a fair bit of this historical underperformance by active managers is a result of their high-fee structures. After all, active managers will need to outperform their relevant benchmarks by at least the management fee percentage before they start to add value to investors. As an example, the below chart illustrates the difference in an investor’s return over 10 years assuming (1) an investment of $10,000 commencing in January 2008, (2) the performance of the S&P ASX Accumulation 200 Index, and (3) a fee of 0.40% p.a. on the one-hand vs a fee of 1.5% p.a. on the other.
Source: BetaShares, illustrative only. Performance not indicative of any fund or ETF. You cannot invest in an index. Past performance is not indicative of future performance.
As you can see, the difference in fees paid over a ten year period can be quite profound. From an initial investment of $100,000, the savings to an investor in fees alone would be over $14,000! This illustrates one of the key benefits of low-cost ETFs.
How are ETF Fees Deducted?
Assuming Betashares ETF “A” has a management fee and ongoing expenses (sometimes called the “expense ratio” or “management costs”) of 0.5% p.a. and that an investor has bought $10,000 worth of ETF “A”, the cost over the year to the investor would be $50.
In practice, the fees are taken into account daily and reduce the overall value of the ETF and so are not required to be paid directly to the fund manager by investors from another source (the fees are reflected in the ETF’s daily net asset value). In the example above, for every $10,000 invested, the ETF’s value is reduced by approximately 14c daily.
This $50 cost is simply deducted from the total pre-fee return of the ETF to give the investment’s current value. For example, if ETF “A” was to return 0% for the year, the investor would expect their holding to be worth $9,950 at the end of the year, if ETF “A” returned 10%, the investor would expect their holding to be worth $10,945 at the end of the year.
So there you have it! Fees really do matter!
PS: If you’re looking for a cost-effective way to access to the broad Australian sharemarket, you may be interested to check out QOZ – or the BetaShares FTSE RAFI Australia 200 ETF, which costs 0.40% per year.