This article was updated on 28th November 2019.
There is no doubt that the overall investment cost differences between Exchange Traded Funds (ETFs), traditional unlisted Managed Funds and Listed Investment Companies (LICs) have contributed to the significant in-flows and growing investor interest in ETFs over the past few years. While the benefits of investing in ETFs are varied, and have been discussed at length, it is worth having a look at some of the numbers, and comparing the difference over time that a low cost ETF can have on an investor’s overall portfolio, when substituting out from a Managed Fund or Listed Investment Company.
Actively managed investments, such as Managed Funds and LICs will typically charge higher management fees than passively managed ETFs, even when their investment exposures are similar. Investors then have to factor in any performance fees, which some funds charge for outperforming their given index or benchmark. Scrutiny on fees has become even more marked when one considers the statistical record of active managers compared to their benchmarks.
In our view, S&P Dow Jones Indices has been the de facto scorekeeper of the ongoing active versus passive debate since the first publication of the SPIVA U.S. Scorecard in 2002.
The latest SPIVA® report was published in June 2019. It illustrates that in the 12 months ending June 2019, active Australian large-cap equity funds recorded an average return of 6.3%, being well below the S&P/ASX 200 gain of 11.6%. Additionally, of the funds in this category, 93.2% and 96.3% failed to outperform the benchmark on both an absolute and risk-adjusted basis, respectively.
As you will see from the exhibit below, the numbers are generally not much better for managers focused on other categories either.
Source: S&P Dow Jones Indices LLC, Morningstar. Data as of June 30, 2019. All index returns based on total return in AUD. Past performance is not an indicator of future performance.
There seems little doubt that a fair bit of this historical underperformance by active managers is a result of their higher-fee structures. After all, active managers will need to outperform their relevant benchmarks by at least the management fee percentage before they start to add value to investors.
To illustrate the impact of fees, consider a simple example. Imagine an investor makes an initial $10,000 investment in the Australian sharemarket that grows in real terms by 5% p.a.
If the investor had paid the average Australian active investment management fee of 1.55% p.a., over 10 years that initial investment would have grown to be worth a respectable $14,027, the impact of fees being $2,262. Not bad, you might say.
|1.55% Management Fee||0.07% Management Fee|
|Value at period end||$14,027||$16,176|
Source: Illustrative only. Performance not indicative of any fund or ETF. Does not take into account any other fees or costs that may apply, such as performance fees or transactional & operational costs. You cannot invest in an index. Past performance is not indicative of future performance.
As you can see, the difference in fees paid can be quite profound. From an initial investment of $10,000, over the 10 year period the difference in fees alone is $2,149! This illustrates one of the key benefits of low-cost ETFs.
How are ETF management fees deducted?
Let’s use BetaShares Australia 200 ETF again as an example. A200 has a management fee of 0.07% p.a.. An investor that buys $10,000 worth of A200 units would incur $7 in management fees over the year.
This fee is taken into account daily within the fund, it is not paid directly to the fund manager by investors from another source (i.e. the fees are reflected in the ETF’s daily net asset value). In the example above, for every $10,000 invested, the ETF’s net asset value is reduced by approximately 1c daily.
The fee is simply deducted from the total pre-fee return of the ETF to give the investment’s current value.
To illustrate this in a simple example, if A200 was to return 0% for the year, the investor would expect their initial $10,000 holding to be worth $9,993 at the end of the year. If A200 returned 10%, the investor would expect their holding to be worth $10,992 at the end of the year.
So there you have it! Fees really do matter!
There are risks associated with an investment in the Fund, including market risk, security specific risk, industry sector risk and index tracking risk. For more information on risks and other features of the Fund please see the Product Disclosure Statement.