Low ETF fees are the gift that keeps on giving – and compounding
One of the biggest mistakes you can make in investing is to lose sight of the importance of low fees.
They are a vital part of the total return equation, particularly over time as compound returns on what could have been paid as fees remain invested.
After a while, perhaps it might seem a bit futile or pernickety drilling down into the details of a particular Exchange Traded Fund (ETF) or listed investment company to check out how big their fees are.
The same applies when looking at spreads or entry and exit prices and also performance fees that some fund managers charge.
However, even picking out some small fee differences in what are otherwise identical products can produce its own form of compounding investment which can transform the eventual result over many years.
An example of the importance of fees
Using an admittedly exaggerated although far from impossible example, let’s see what happens when you pay a fee of 0.3% compared to 1% a year.
If you invest $100,000 for 20 years on an average annual return of 8% and a 1% management fee, it would grow to about $386,970.
The exact same investment with a 0.3% management fee would grow to around $440,870.
That is a significant difference in anybody’s language and certainly justifies the initial research to find the lowest fee.
Looked at in a different way, the extra return of $53,900 means you got 53.9% more on your investment over time – proving the vital importance of fees over time even when they appear to be quite small.
Even ASX 200 ETFs are different
Moving from a hypothetical example to a real life one, let’s have a look at ETFs that cover the ASX 200 index – the sort of ETF that many investors would have as a core holding.
Recently Morgan Stanley analysts looking at such ETFs decided that the BetaShares Australia 200 (ASX: A200) was the pick of the bunch, with fees a vital part of that finding.
Some of the other factors looked at to decide which ETF was best included exposure, product structure, risk metrics, liquidity, profitability and performance.
That last factor seems unusual given that all three ETFs examined – the other ones being iShares Core S&P/ASX 200 (ASX: IOZ) and the SPDR S&P/ASX 200 (ASX: STW) – cover the same ASX 200 index, so surely their performance will be identical?
Even index ETFs perform differently
It turns out that is not exactly true given that there are small differences in index and portfolio construction, with the BetaShares ETF not only having the lowest management fees at 0.04% a year, it also had the best performance.
One of the reasons for this is that the iShares Core S&P/ASX 200 and SPDR S&P/ASX 200 both track the S&P/ASX 200 Accumulation Index, while BetaShares Australia 200 tracks the Solactive Australia 200 Index.
While Morgan Stanley describes the differences in construction methodology between these two indices as “negligible” which allows for their direct comparison, these differences plus the slightly lower fees did change the result, with the Betashares product producing “slightly better performance” than its peers.
All three ETFs include the same 10 companies – BHP, Commonwealth Bank, CSL, National Australia Bank, Westpac, ANZ, Wesfarmers, Macquarie, Goodman Group and Woodside Energy – in their top holdings.
The financial sector accounts for 30% to 31% of each portfolio, followed by materials at 22% to 23% and healthcare companies were 10%.
Ranked differently in various areas
In looking at some of the different aspects of each fund, Morgan Stanley found that iShares Core S&P/ASX 200 and SPDR S&P/ASX 200 ranked slightly ahead on its exposure assessment and it placed iShares Core S&P/ASX 200 first for product structure because it offers both an in-kind and cash creation and redemption process.
“We prefer liquid, easy to track benchmarks that provide ample diversification,” the broker wrote in its analysis.
“In-kind redemption avoids capital gain tax events at the fund level.”
All three ETFs had similar risk metrics with the BetaShares Australia 200 slightly ahead for its ability to minimise volatility while maximising risk-adjusted returns.
The BetaShares ETF also comes out on top for fees, with both a lower management fee and total cost of ownership, partly due to the underlying index being lower cost and a slightly different construction methodology.
Its management fee and total expense ratio are both 0.04%, followed by iShares Core S&P/ASX 200 with a management fee and total expense ratio of 0.05% and the SPDR S&P/ASX 200 with a management fee of 0.05%.
The importance of lower fees is that more capital remains invested and earning compounding returns.
With extra features come extra fees
In this case all of the ETFs have reasonably low fees so even the long-term differences won’t be as large but they can still be important when you consider that some of the smaller and less popular ETFs have fees closer to 1% or even higher.
Of course, extra features such as gearing or hedging come at an extra price but even when looking at specialised funds, fees are an important part of the equation.
Similarly, brokerage costs can be significant over time, so the advent of brokerage free purchase platforms by some of the larger ETF providers are an ideal way to build up a core holding over time through the benefits of mechanical investing and dollar cost averaging while saving on brokerage at the same time.