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ETFs: Not always so cheap

Herbert Lian Published on Mon, Feb 13, 2017 / 3:06 PM GMT+8

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SINGAPORE (Feb 13): Those who have been following this column will notice that I often make reference to investing in an entire stock market. As preposterous as it may initially seem to buy a whole stock market’s worth of shares, this can actually be very simply done through a class of financial products known as exchange-traded funds (ETFs).

At its simplest, an ETF pools money from its investors in order to buy every stock in the stock index that it is supposed to replicate. This stands in contrast with actively managed funds (also called unit trusts), where the fund manager does not buy the whole index, but only stocks that he thinks will do well. An active fund can do much better than the stock index, but it can also do much worse. In contrast, an ETF aims to return the same profits as the stock index, less any fees and expenses charged by the ETF provider.

In recent years, ETFs have gained popularity at the expense of active funds for one key reason: cost. Active equity funds often charge 1.5% per year in management fees, and about 1.7% to 2% once other expenses are included (although these figures vary widely). In contrast, the world’s largest ETF by assets, the SPDR S&P 500 ETF which tracks the US Standard & Poor’s 500 stock index, charges a miniscule 0.09% per year, including ex penses. An active fund manager’s US stock picks would thus have to do much better than the S&P 500 index to make up for the difference in fees and be more profitable for an investor than the ETF.