Do ETF Investors Care About Expense Ratios?

by: IndexUniverse

By Matthew Hougan

Jim's ETF revenue analysis raises an important question: Do investors care about expense ratios?

Jim's table brought this to mind because of the huge discrepancies between assets and revenues. SSgA has about half the assets of BGI, but only one-quarter the revenues. ProShares is nipping on the heels of PowerShares on revenues, but has less than half the assets.

My favorite is Vanguard. Poor Vanguard has $44 billion in assets and $60 million in revenues. Van Eck - with just $5.8 billion in assets - has $30 million in revenues.

Even beyond these fund family comparisons, though, there's ample evidence that investors overlook expenses.

Consider this: The iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) charges 0.75% in expenses and has had trouble tracking its index in the past. Vanguard offers a competing ETF (the Vanguard Emerging Markets (NYSEARCA:VWO)) that tracks the exact same index, charges 0.30% and has a strong tracking record. But EFA has $24 billion in assets, while VWO has $6 billion. Go figure.

Another example? The MidCap SPDR (NYSEARCA:MDY) tracks the S&P 400 and charges 0.25% in expenses. It has $8.2 billion in assets. The iShares S&P 400 MidCap ETF (NYSEARCA:IJH) tracks the same index and charges 0.20%. It has $4.4 billion in assets.

The same trends exist for funds tracking different indexes in the same market. Of the three available China ETFs, SSgA's China fund (NYSEARCA:GXC) offers the most diversified exposure to that market. It charges 0.60% in expenses and has $83 million in assets. Competing funds from iShares and PowerShares ((NYSEARCA:FXI) and (PJG)) charge significantly more (0.74% and 0.70%) and yet have significantly higher assets ($6.3 billion and $475 million).

(The ETFs differ and the choice should be based on more than expense ratios - like whether you want large- or small-cap exposure, focused or diversified portfolios, etc. But if investors cared significantly about expenses, GXC would have more assets.)

The biggest clue that investors don't care enough about expense ratios is that fund companies don't market toward it. Except for Vanguard (and Rydex on its leveraged funds), you don't see aggressive price competition. You see ETFs launching today with expense ratios of 0.85%, 0.95% or more. You see every commodity futures ETF under the sun using the same 0.75% price point. (Can't someone hit 50 basis points?)

Why don't investors care? There are a lot of reasons. For one, expense ratios are only one part of the equation. I have an article in the forthcoming (May) issue of ETFR that looks at the impact of spreads on ETF costs. It's the first time I've seen spread data broken out on an industry basis, and it's telling: In many cases, spreads overwhelm any expense ratio advantage.

But expenses remain one of the only things we can really control in our portfolios, and we'd do well to pay more attention.

One more note: One of the reasons that ETFs have been so successful is that they are branded in people's minds as "low-cost alternatives." Let's hope that stays true, or growth for the entire industry could slow significantly.