Active fund managers have been living it up at our expense, siphoning off £7bn a year from the nation’s retirement pots, according to The Daily Telegraph. And their expense ratios have been rising, even as stockmarket performance has been mediocre, to say the least. So are passively managed exchange-traded funds (ETFs) a better deal? Clearly, the answer is yes. The average total expense ratio (TER) on an ETF is 0.3%, compared to a common 1.5%-2% for actively managed funds. ETFs also have no 5%-6% upfront charge, nor do they pay commissions to financial advisers.
However, as one City analyst has said, you stand a better chance of understanding a mobile-phone contract than how fund fees are levied. There are plenty of ways to get caught out, even with ETFs. So here are some vital tips on getting the best deal.
Check platform fees and shop around
One popular platform, Hargreaves Lansdown, charges 0.5% to hold an ETF within its Isa or Sipp, for example. You can also cut trading costs by avoiding buying or selling ETFs when the underlying market is closed. And try to use stop or limit orders (which set a fixed price at which you’ll buy or sell), rather than paying the full bid-offer spread. Alternatively, buy on a regular monthly trading plan, with lower broker charges.
Understand the investment
Just because it’s indexed or passive doesn’t mean it’s worth buying. Some exchange-traded commodity (ETC) investors had a shock in 2009 when spot oil and gas prices went up, but their investments didn’t due to the effect of contango, for example. And check the historic tracking error on the fund provider’s website – look at how well the fund’s net asset value has mirrored the index. Some emerging-market ETFs have been several percentage points adrift of their benchmark, for example. Might you be better off with an active fund, after all? Others have lagged their benchmarks because of swap costs (charges paid by the fund to the banks writing the ‘swaps’ that guarantee its index performance).
Check the tax treatment of dividends
For ETFs investing overseas, the index often assumes that withholding taxes are levied at the maximum rate. This can take up to a third off your dividend income, even though the managers can sometimes achieve better dividend treatment than this. Are they passing any extra earnings to you, or pocketing them? Ask them.
• Paul Amery edits
www.indexuniverse.eu