When Cheaper Is Not Better With ETFs

Since the SPDR S&P 500 SPY came to market in 1993, one of the calling cards of the exchange-traded products industry has been costs. Costs associated with most ETFs easily trump those of mutual funds and those differences in expense ratios mean big differences over time in terms of returns to investors. Last year, mutual fund investors paid an average of 0.75 percent in expenses. It is hard to envision the ETF business being able to survive let alone rival mutual funds if the average ETF cost 75 basis points per year. The reality is low fees are the backbone of how many ETF providers attract assets. It is low fees that explain the rapid ascent of Charles Schwab SCHW up the ETF ladder and it is low fees that explain why Vanguard is one of the truly dominant U.S. ETF sponsors. In most cases, Vanguard's fees undercut rivals on similar funds. That strategy has allowed the company to amass over $208 billion in ETF assets as of the end of June and highlights why some rivals are worried about Vanguard's stunning growth in the ETF business. A prime example of Vanguard's ability to stick it to rivals when it comes to costs is the Vanguard MSCI Emerging Markets ETF VWO. Once upon a time, VWO had what was perhaps the ETF world's best rivalry going with the iShares MSCI Emerging Markets Index Fund EEM. That rivalry perished quickly because investors realized the two funds essentially do the same thing, but VWO charges just 0.2 percent per year compared to the 0.67 percent charged by EEM. The result: VWO had almost $64 billion in AUM at the end of June. EEM has $34.1 billion in AUM. The VWO/EEM rivalry serves as a reminder that if two ETFs do almost exactly the same thing, broadly speaking, it is advantageous for long-term investors to opt for the fund with the lower fees. However, there are some noteworthy examples in the ETF universe where cheaper is not always better. In the following examples, the more expensive ETF with the better performance is in bold. Vanguard Consumer Discretionary ETF VCR By a small margin, the Vanguard Consumer Discretionary ETF is more expensive than the Consumer Discretionary Select Sector SPDR XLY. XLY charges just 0.18 percent year while VCR charges 0.19 percent. Regarding performance, the comparison is not completely apples-to-apples because VCR is currently home to 373 stocks while XLY holds just 83. In terms of AUM, XLY is almost six times larger than its Vanguard rival. Superficial statistics aside, performance is where these two ETFs really diverge. Over the past five years, XLY is up 12 percent. That is fine, but unimpressive when compared a 17.4 percent jump for VCR. iShares High Dividend Equity Fund HDV When measured against the Vanguard Dividend Appreciation ETF VIG, the largest of all dividend ETFs, the iShares High Dividend Equity Fund does look expensive with annual fees of 0.4 percent compared to 0.13 percent for VIG. VIG is also far larger in terms of holdings with 133 compared to 75 for HDV. The ETFs do not track the same index and that fact may mute this comparison to a certain extent. That said, both are dividend ETFs, but in the past year, HDV has shown it is worth paying up for. While VIG is up 7.8 percent, HDV has jumped 20.4 percent. HDV also has the higher yield. First Trust Brazil AlphaDEX Fund FBZ The First Trust Brazil AlphaDEX Fund charges 0.8 percent per year, which is more than 20 basis points higher than the fees on the iShares MSCI Brazil Index Fund EWZ. And with $5.6 million in AUM, FBZ is merely a barnacle on the $7.5 billion whale that is EWZ. Still, FBZ offers a big advantage over EWZ and that is that the former tracks a different index. That means FBZ does not feature excessive weights to Petrobras PBR and Vale VALE, two beaten up Brazilian commodities giants. Neither ETF has been great this year, but FBZ's loss of 5.4 percent is better than EWZ's seven percent slide. For more on ETF fees, click here.