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The issue of cost

Jun 22 2010 08:42
Typically, an investor looking for an index-tracking product will be a long-term one.

Low costs are the chief attraction of ETFs. And while some traders may use ETFs for short-term positions on the market, or for shorting an index, a long-term investor knows how important costs are.

High costs without significant and consistent outperformance of a benchmark can substantially erode the final total return, probably at retirement when an investor needs the money.

As passively managed products trying to replicate an index as closely as possible, ETFs have no asset management fees.

That in itself is a significant saving for investors.

Actively managed unit trust funds can charge up to 2% and even higher for the skills of the fund manager. That’s fine if the fund consistently outperforms – but shrinks the return if it doesn’t.

Total expense ratios (TERs) for ETFs are also much lower, up to one-third of the cost of the lowest priced unit trusts.

And with the exception of the Rafi and eRafi ETFs (see separate report) there are no performance fees.

However, the problem is that while still relatively new and often not that well known among retail investors, ETFs will probably reach the investor via the cost-absorbing food chain of financial advisers, stockbrokers and linked investment service providers (Lisps).

Fees paid to advisers and Lisps are typically lower for ETFs.

However, they’ll add to the costs.

But the knowledgeable investor will know these costs can be avoided.

Investors who know what ETF they want and don’t require financial advice can buy the products directly through one of the ETF investment platforms, at least one available on the internet.

However, the lower fees paid to Lisps and lower commissions to financial advisers are probably slowing what has nonetheless been the strong growth of ETFs.

As with so many investment and savings products, sales and distribution are the name of the game.

The financial adviser network is a large distribution channel, so why is a financial adviser going to punt an ETF to earn only 1% when up to five times more can be earned from the commission of a unit trust (though those have generally been beaten down to around 2%)?

It’s not unlike what happened many years ago to unit trust funds when those cheaper products began to replace the exorbitantly expensive life insurance funds as the underlying investments in annuities.

But just as investor pressure forced advisers to start backing cheaper unit trusts back then, so it will be needed now to get ETFs recognised.

If an investor hasn’t been offered an ETF for his portfolio they should ask their adviser why. And if the investor is sure he wants an ETF, that’s what he must demand.


 - Finweek

investment  |  etfs
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