Why you need to worry about more than the expense ratio for ETF’s

By: ispeculatornew
Date posted: 03.19.2010 (4:00 am) | Write a Comment  (4 Comments)

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Generally, I have been a major supporter of ETF’s, especially when compared with mutual funds alternatives. Two of the main reasons are how transparent they are and because of their low fees. Yesterday, when I published the list of the Top 50 Low-cost ETF’s, many were surprised to see some ETF’s with 0% MER (annual fees). I was as surprised and decided to take a deeper look into these funds. I found something that is not new but I had not noticed before. These ETF’s do not have the typical fee as a % of assets but rather have a fixed fee per share. In the case of OIH for example, that fee is a small 0.08$/share/year. That is insignificant and remains a muxch lower cost choice than the usual alternatives. The reason of course for this insignificant fee is that these funds do not rebalance and do not change. That has a lot of disadvantages, but one of the main advantages is little to no trading cost which means a very cheap fund in terms of fees. So yes, a fund like OIH is probably as cheap as you can find in terms of annual fees.

Then what is the problem?

However, what I don’t like about this is that such fee ratios do not give investors the whole picture. It is similar to other funds who charge an annual fee but also has other types of fees that are added in without being clearly stated. Of course, any investor can simply grab a prospectus like I did for OIH and find the exact fees that will be charged. But how many of you do that? I certainly don’t usually do so and probably would not have looked if I had not been writing about it.

Solutions?

I think it’s fair to ask from these funds to give their best indication of the fees to be expected in advertisements but also any other documents about the funds. Such funds could be estimated. For example, the fee per share of 2$ per 100 shares every year for OIH could be translated into an annual expense ratio. Sure, every time the price of OIH changes, that expense ratio will also be impacted. But an approximation is better than simply ignoring these changes.

Why the worry?

I worry about such disclosures (or lack of) because over time they can be abused and potentially ETF’s could lose their good name if such fees become more used. Why promote a fund with .50% fees if you can promote it at .15% and then have .35% of “other fees”.

What are your thoughts? Will ETF’s become another area of abuse by Wall Street firms?

OIH

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4 Comments

  1. Comment by John — March 19, 2010 @ 7:51 am

    I think we should be careful with zero-fee ETFs. It’s a total “marketing gimmick”… Transparency and Clarity are crucial. Don’t you think there should have some regulations about this? Tks.

  2. Comment by Catarina — March 19, 2010 @ 7:55 am

    How to read an ETF prospectus? I think you should write on this 😉 I’m receiving these iShares brochure but I’m completely lost and don’t know what to check! Thank you.

  3. Comment by Daddy Paul — March 24, 2010 @ 8:03 pm

    Good read. I learned something.
    One thing about fees they tend to get bigger over time.

  4. Comment by IS — March 26, 2010 @ 4:00 pm

    @John – I’m sure it will come eventually but like everything else, it will probably come after some abuse

    @Catarina – It takes a while honestly, I think they are generally pretty clear in the prospectus so you can generally look in the fees section and it will be right there.

    @Daddy Paul – what do you mean biger? In ETF’s, I would say many ETF’s have reduced their fees as they got bigger.

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