When you invest your hard-earned money into an ETF do you pay attention to whether this fund is actively or passively managed and how much you will be paying in fees? Well if you haven’t before you should take this seriously as it can have a huge effect on your returns.
The Securities and Exchange Commission felt that this was something that retail investors lacked basic education on and they dedicated a report to it on their Investors Alerts and Bulletins Board, so that is what we will cover in this blog post.
Active vs Passive… Huh?
A bit of housekeeping before we get on to the meat of this blog post. For anyone that is not up to speed. Let us briefly differentiate between what is a actively managed and what is a passively managed fund.
A passive fund will usually try and track the performance of an index like the S&P 500, FTSE 100 CAC 40, or Russell 2000. Its primary goal is to replicate the performance of the underlying Index. For Example, the investment policy of Vanguard’s VUSD fund is to track the S&P 500.
As this strategy is relatively easy to execute, it does not require a huge amount of resources to achieve the result. Due to this passive funds tend to have relatively low fees.
An actively managed fund on the other hand set out to beat the market and achieve excess returns for its investors by employing expert driven investing strategies. This requires significantly more resources and therefore normally come with much higher fees attached.
Even though actively managed funds aim to beat the market, this does not mean that they actually achieve that goal very often. According to Morningstar, only one in every four active funds topped the average of their passive rivals over the 10-year period ended June 2022.
This is how fees charged on ETFs
Buried in the detail of the Fact Sheets and Key Investor Information Documents, that are required to be issued with all funds that are available to EU investors, you will find the expense ratio.
The expense ratio signifies the fees that are charged to the assets of the fund to cover expenses such as salaries of fund managers, administration and reporting fees, and is quoted as a percentage.
For example, the iShares MSCI Emerging Markets Small Cap UCITS ETF has an expense ratio of 0.74% per annum – fees are spread throughout the year and are charged daily.
The affect of the expense ratio on your returns
The best way to illustrate just how material an affect the fees charged on ETFs are, we will go through a real life example.
In the following example, we’ve assumed that you invested €10,000 in 5 different hypothetical ETFs in 2013 and made no further investment – leaving them untouched until 2033 (20 years).
The only difference between these 5 investments was the expense ratio ( 0%, 0.25%, 0.50%, 0.75% and 1.00%).
Lastly, we have assumed that each ETF has grown at a rate of 4% per annum every year.
As you can see from the table below, even for just a €10k investment the fees can be very material over 20 years. An investor who paid no fees ( basically invested in stocks instead of an actively managed fund) that was charging annual fees of 1% was better off by €3,990 (assuming both investments grew at a rate of 4% p.a).
|Expense Ratio||Investment Value 2033||Fees|
We are not talking about a huge sum of money invested here – when it comes to someone who routinely invests a couple of thousand euros every year, this effect is magnified significantly.
What Can You Do?
Although you might not think it, doing a couple of minutes of due diligence can be very valuable down the line, even though you will never see the result of it.
Your first port of call for any ETF investment should be to check out the Key Investor Information Document and the Fact sheet to get some of the key details about what you are investing in – especially the fees.
If the fees are high, the only way to justify it is if the fund has shown a potential to beat the market over the long term, but in reality, the fund managers would need to be something fairly special to be able to do this consistently. So be cautious in giving away some of your funds in fees if you are getting nothing in return.
Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.