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Too Much Emphasis on ETF Fees Can Distract Investors

Asset managers are racing to lower fees for their ETFs to attract assets. Low expense ratios are eye-catching, but investors need to dig deeper to understand how similar sounding ETFs actually have different exposures and disparate performances.

Four months ago, State Street Global Advisors shook up the already competitive exchange traded funds industry with fee reductions on 15 funds and placed them on a commission-free platform. Although Vanguard, iShares and Schwab have continually cut fees on broadly diversified index ETFs for years, SSGA largely stayed out of the fray, even as advisors and investors flocked to the other low-cost options. However, since the mid-October announcement, assets in SSGA’s newly priced ETFs nearly doubled to $22 billion (as of Feb. 20), according to Bloomberg data. In addition, they gained market share against competing funds with the same investment style.

Assets in SSGA’s SPDR Portfolio S&P 500 Value (SPYV), for example, tripled in size to $1.1 billion since mid-October, aided by more than $700 million of net inflows. SPYV’s fee was cut by 11 basis points to 0.04 percent. In contrast, iShares S&P 500 Value (IVE) and Vanguard S&P 500 Value (VOOV), which own identical positions, but charge 18 and 15 bps, respectively, gathered $220 million and zero assets in the same period. All three ETFs lost approximately 1 percent year-to-date through February 20, 2018, after rising 15 percent in 2017.

According to Matthew Bartolini, Head of SPDR Americas Research at SSGA, the addition of the aforementioned SPDR Portfolio ETFs to a commission-free platform helped to support asset growth with retail investors, but the 15 ETFs have also seen strong flows from institutional investors and were added to home office ETF models at brokerage firms, encouraging advisor usage.

During a video with CFRA taped at Inside ETFs, Bloomberg Intelligence’s Eric Balchunas explained that investors are saving a ton of money with “eating your vegetables”-type products. He added that advisors are obsessed with the cheapest products, which will continue to drive fees lower.

We agree with Balchunas that investors can “over trust” the fee when making a decision to put money in a fund. In truth, what is inside some low-cost funds can be notably different, impacting performance.

In rating more than 1,300 ETFs, CFRA combines fund-level attributes, including expense ratio and trading costs, with holdings-level analysis. An ETF’s future return is not driven by past performance success.

As examples, assets in SPDR Portfolio Emerging Markets ETF (SPEM) nearly doubled to $1.6 billion, aided by more than $900 million of net inflows since its expense ratio decreased to 0.11 percent from 0.59 percent and it was added to a commission-free platform. Meanwhile, iShares Core MSCI Emerging Markets (IEMG) and Vanguard FTSE Emerging Markets ETF (VWO), which both charge 0.14 percent, gathered $6.4 billion and $880 million, respectively, in this period. Schwab Emerging Markets Equity (SCHE) gathered $600 million and has a 0.13 percent expense ratio.

IEMG and SCHE can be purchased commission free on different self-directed platforms than the one SPEM is now found on.

Year-to-date through February 20, 2018, SPEM and SCHE were the leaders of the quartet, up 5.0 percent, ahead of VWO’s 4.3 percent and IMG’s 3.5 percent. Yet, in 2017, SPEM generated a 35 percent total return, lagging IEMG’s 37 percent gain, but ahead of the 33 percent and 31 percent for SCHE and VWO, respectively.

The approximately 600 bps differential between diversified emerging market ETFs highlights the importance of understanding what’s inside. For example, SPEM has more exposure to China than the three emerging market ETF peers, but it doesn’t have the exposure to South Korea as IEMG does. These four ETFs track indices from three different providers, unlike the above value trio, are all tracking the S&P 500 Value Index.

While SSGA’s suite of asset allocation funds have eye-catching lower expense ratios than iShares and Vanguard, the firm is not the price leader for U.S. sector ETFs. That distinction goes to Fidelity, which offers 11 sector ETFs at a miniscule 0.08 percent expense ratio. SSGA charges 0.13 percent, following a one-bp fee cut in February 2018, while Vanguard charges 0.10 percent.

Paul Baiocchi, a VP of sector and ETF investment strategy at Fidelity, told CFRA in a recent video that sector ETFs provide investors with the clarity of exposure that a lot of investors crave when picking individual stocks, but without the single security risk.

Despite similar-seeming objectives, Fidelity MSCI Information Technology (FTEC) and Technology Select Sector SPDR (XLK) do not perform in line with one another. In 2017, FTEC’s 37 percent gain was stronger than XLK’s 34 percent return; year-to-date, FTEC was approximately 100 bps stronger. FTEC is a multi-cap offering focused solely on technology stocks, while XLK holds only S&P 500 companies in the tech and telecom services sectors.

Todd Rosenbluth is Senior Director of ETF and Mutual Fund Research at CFRA where he leads the firm’s holdings-based research efforts within the Equity Research and Fund group. 

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