Europe’s largest exchange-traded fund (ETF) is now iShares’ S&P 500 ETF (LSE: IUSA), which overtook Lyxor’s Euro Stoxx 50 ETF (Paris: MSE) in late 2010. The fund has doubled in size in just a year. This means the largest ETFs in both the European and US markets now follow the same US large-cap index (the world’s largest ETF is the SPDR S&P 500, with close to $100bn in assets). IUSA’s growth rate is all the more remarkable for the fact that a ten-year exclusive deal between iShares and S&P expired last May, leading to a flurry of competing S&P 500 ETF launches. All the new funds were offered at a lower cost than the iShares fund (they have total expense ratios of 0.15-0.25% a year, against IUSA’s 0.4%).
Yet the new ETFs haven’t taken market share away from iShares – in fact, the reverse is the case. IUSA has stretched its lead, as measured by funds invested. Why? One answer is that first-mover advantage and brand name are clearly important in the ETF market and iShares remains the dominant global name.
But perhaps more important is the iShares fund’s superior liquidity. The London Stock Exchange recently measured IUSA’s average bid-offer spread (the gap between buying and selling prices) as 0.07%, compared with between 0.1% and 0.3% on the funds offered by competing issuers.
So if you were to buy and sell the rival ETFs a couple of times a year, then the iShares fund’s lower ’round-trip’ trading cost would easily make up for its higher fees. And because ETFs tend to be traded heavily – turnover in the most widely owned US ETFs is several thousand percent a year, for example, with average holding periods only a few days long – those dealing costs matter.
Whether it makes sense for the average investor to trade so actively is another question entirely. John Bogle, the founder of US fund manager Vanguard (and the godfather of index investing), has been highly critical of this aspect of ETFs, claiming that investors are destroying their savings by overtrading, and this makes sense to us. Although liquidity is important, particularly in more obscure ETFs, if you are looking for a buy-and-hold investment, it’s worth looking beyond the biggest names, and if you’re looking at the US specifically, also consider alternative tracker vehicles too. All of these ETFs deduct 30% from the dividend income they receive from US shares, and you may get a better yield from UK-domiciled index funds.
• Paul Amery edits
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