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April 4th, 2013 by Scot Blythe

Are ETFs Cheaper? By Scot Blythe

 

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As ETF assets grow, there is pressure to reinvent the wheel. It’s natural because many investors don’t want just beta. They may want dividends; they may want low volatility; they may want enhanced indexing. There is, for example, now a covered-call ETF on BRIC countries.

But these add-ons come at a cost. And that cost means that ETFs are not necessarily cheaper than mutual funds—at least in the U.S. That’s what Vanguard Group strategist Joel Dickson told Barron’s magazine recently.

His argument rests on two factors. First, passive ETFs should be compared with index mutual funds and active ETFs should be compared with active mutual funds. Second, analysts should follow the money. It’s not enough to compare the MER of the average ETF with that of the average mutual fund. Instead, the comparisons should be dollar-weighted.

It turns out that American investors are price-conscious. In the passive arena, they pay 15 basis points for index mutual funds and 30 basis points for ETFs. One reason is that some ETFs are using costlier enhanced indexes. For example, WisdomTree’s Japan Hedged Equity ETF (recently spotlighted on Benzinga.com, an ETF trading site) focuses on companies whose earnings are derived from exports rather than the moribund domestic economy.

Also, while 97% of U.S. ETFs track indexes—some of consequence, some of no consequence, Dickson notes—actively managed ETFs are slightly more expensive, on a dollar-weighted basis, than actively managed mutual funds.

Of course, the U.S. marketplace is not directly comparable to Canada’s. Canadian mutual funds have embedded advisor compensation. U.S. funds normally do not. Instead, it’s pay-to-trade with a broker—and some brokerage firms are offering free ETF trading—or else clients sign up with a Registered Investment Advisor, who also has a fiduciary obligation, on a fee-for-service basis.

That split between trade facilitation and advice is not as distinct in Canada. In the interim, however, it gives fee-based advisors a leg up on advisors who rely on embedded sales commissions.

Originally published on Advisor.ca
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