Do ETF Investors Care About Expense Ratios?

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 (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 (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 (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 (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 (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 ((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.

Comments

[globalmacro:]

Just another example of how the average investor remains clueless. I guess we can't expect most people to be smart enough to realize that if they pay 20% less for their investment products that its just as good as paying 20% less for a pair of shoes. In fact, its significantly more important to play less for investment products due to the insidious effect of small fee differences when compounded over time. Just look at the disaster the average American worker is headed towards due to the proliferation of 401k plans with 3%+ fees. The impact is truly ASTOUNDING.

2008 Apr 24 04:12 AM

[BSCLossMan:]

I agree with everything said. I look closely at the expense ratios of ETFs, and I am tired of hearing that ETFs have low expense ratios for the various professionals who talk about ETFs. Many ETFs have equal or higher expense ratios than mutual funds.

2008 Apr 24 04:42 AM

[E F Nuttin:]

The key to selling ETF's is who hits the market first. If you hit the market first you can charge more, because you have a monopoly in your sector and you get the volume that people want when trading. I love Proshares ETF's and would only consider Rydex double ETF's in my taxable account, if I was going to hold it at least a year. Rydex doesn't have the daily volume to get in and out. If 401k's used ETF's the lower cost one would dominate, but most people who buy ETF's are traders.

2008 Apr 24 08:30 AM

[adan:]

i'm "very" new to using any etf's, and though i don't know if it's really a valid reason, i tend to choose an etf with larger daily volumn; call me scared

but i wouldn't mind reading pros and cons re whether a higher / lower daily volumn is important re an etf

thanks!

2008 Apr 24 11:43 AM

[drbagel:]

Once the money is in the ETF, an investor cant switch without triggering cap gains taxes (unless its in a retirement account). First to market is a huge advantage.

2008 Apr 24 12:28 PM

[E F Nuttin:]

If a ETF wants to gain more market share all the have to do is buy and sell their own ETF for the specific reason of creating volume. We don't like huge spreads between bid and ask.

2008 Apr 24 02:08 PM

[I B Urdaddy:]

You guys are idiots. iShares MSCI Emerging Markets ETF is actually not (EFA), it is instead (EEM). EFA is an ETF for developed markets and has actually been tracking its benchmark. Maybe you should actually look into what is written instead of taking it as the gospel.

2008 Apr 25 12:28 PM

[lemming:]

Yay! im an idiot, so should I buy EFA or EEM i am looking for some exposure to the blue chips which one would be better yay!

2008 Jul 03 01:26 AM