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Smart Beta: why the TER is not enough when measuring performance
on Nov 21, 2012 at 12:54
Alan Miller, partner at SCM Private, compares the performance and costs of ETFs versus index trackers
In an exclusive article for Wealth Manager he writes:
As investors become more familiar with exchange traded funds (ETFs), it is important that they do not assume you simply select the fund with the lowest total expense ratio (TER) and this will perform the best.
Most people in the industry know the so-called TER or ‘ongoing charges’ can be thoroughly misleading, particularly when a fund trades actively or charges performance fees. It is equally misleading for trackers.
We analysed 33 FTSE 100 and FTSE All Share ETF or mutual fund trackers over the past three years. The total sum invested in the funds is £22.8 billion. Key findings include:
The performance of index trackers varied significantly – the worst tracker underperformed its index by 2% a year.
The average ETF underperformed by less – the ETFs underperformed by 0.4% per annum, compared with 1% per annum for an equivalent mutual fund tracker.
The average ETF charged less – the reported TER for a FTSE 100 ETF was less than half its mutual fund equivalent (0.37% versus 0.88% a year). The average FTSE All-Share ETF charged 0.4% a year versus 0.67% for the average mutual tracker.
‘Hidden’ costs or performance drag can be significant in mutual fund trackers – the extent to which they underperformed beyond their stated TERs represented an extra 54% of an average mutual fund tracker’s costs, but just 10% of an average ETF tracker.