For many, cost is not the only determinant in making an investment in an ETF and for good reason. There are many other issues to consider besides the expense ratio including diversification, commission-free trading availability, structure, and liquidity. Yet in some cases, cost is really what separates two funds far and above any of the other issues touched upon above.
This can especially be true when two funds track similar—or even exactly the same—indexes but charge very different expense ratios. Generally speaking, when cost is really the only big difference between two funds, one would expect that over time the lower cost product would slowly overtake the lead in AUM. This has been the case in a few products as of late, most famously in the emerging market space with VWO and EEM. Both funds track the MSCI Emerging Markets Index but VWO only charges 22 basis points a year in expenses while EEM asks for 0.69% a year in fees. Until recently, EEM had far more in assets than its counterpart from Vanguard but the gap has slowly closed in the past few months until finally, VWO took the lead in total assets (see Top Three BRIC ETFs).
However, while this trend may be playing out in a number of asset classes across the space, the more expensive option is actually still the more popular one in a number of cases. Below we have highlighted five instances in which this is the case and the only major difference—beyond trading volume—is the expense ratio. Thanks to this reality, many investors may be better served by expanding their horizons and taking a look more closely at all of the options in a particular class of funds but especially so in the following five product types:
Thanks to concerns about the health of Europe and the long-term strength of the U.S. dollar, gold investing has surged in popularity in recent months. Many investors continue to flow into the SPDR Gold Trust (NYSEArca:GLD - News) as a way to play this trend although there are several other products in the space that could also offer great exposure to gold bullion. Chief among them is the iShares COMEX Gold Trust (NYSEArca:IAU - News) which also holds physical gold in secure vaults (read Three Best Gold ETFs).
While both funds hold gold, the main difference between the two is the expense ratio as IAU charges investors just 25 basis points compared to a fee of 0.40% for GLD. While some might assume that trading volumes play a role in this differential, IAU trades close to 10 million shares a day suggesting ample volume for even the biggest traders. Nevertheless, the iShares fund has close to $8 billion in assets while GLD has close to $65 billion, a sizable lead that will take quite some time to eat into.
Small Cap ETFs
For investors seeking a play on the often volatile small cap sector, there are numerous options available. Beyond micro cap funds and products that target various corners of the space—such as value or growth—investors also have multiple options when it comes to broad funds as well. In this space, the iShares Russell 2000 ETF (NYSEArca:IWM - News) dominates the field, having amassed nearly $14 billion in AUM while trading close to 76.5 million shares a day. This comes despite the fact that the upstart in the sector, the Vanguard Russell 2000 ETF (NasdaqGM:VTWO - News) charges far less in expenses but tracks the same Russell 2000 Index (see Three Micro Cap ETFs TO Play The January Effect).
In fact, VWTO has amassed just $53 million in assets and trades just 13,700 shares a day, small figures compared to the gigantic levels seen in IWM. However, while the volume may be weak, it should be noted that VTWO chares just 15 basis points a year in fees compared to 26 for IWM. While this might not sound like a huge difference, it is nearly half the cost for pretty much identical exposure, a factor that should cause most investors to pause before they choose which product to invest in next time.
Japanese Yen Funds
Although the Japanese economy was rocked by the earthquake and Tsunami in March of 2011, the nation has rebounded quite well and has seen inflows in recent months. This has largely been due to repatriation of assets as well as foreign investors looking to scoop up beaten down assets in a low risk country. Thanks to this, interest in the yen has been strong and most investors continue to choose the CurrencyShares Japanese Yen Trust (NYSEArca:FXY - News) for their exposure. This is despite the fact that another product, the WisdomTree Dreyfus Japanese Yen Fund (NYSEArca:JYF - News) also gives investors exposure to the yen but does so at a slightly cheaper rate (also read Ten Best New ETFs Of 2011).
JYF charges investors 35 basis points compared to the 40 charged by FXY for its services, suggesting that cost conscious yen investors may be better served by the WisdomTree product. However, this hasn’t really been the case so far as JYF has a paltry $13 million in assets compared to a nearly $726 million haul for FXY. This has also produced a huge trading volume discrepancy as just 10,500 shares change hands a day in JYF compared to nearly 310,000 for FXY. Probably due to this heavy difference, the popularity of FXY over JYF looks likely to continue well into the future.
EAFE Region ETFs
While heavy exposure to the regions of Europe, Australasia, and the Far East (:EAFE) may not be a great idea for risk adverse investors at this time, a small allocation to these important parts of the world seems necessary no matter what the broad economy is doing. That is because this region includes five of the ten largest economies in the world as well as several more that are in the top twenty overall. For access to this region, many investors still look to the iShares MSCI EAFE Fund (NYSEArca:EFA - News) for their exposure, as the fund has $37 billion in assets and over 26 million shares a day in volume (see EUFN: The Best ETF For The Euro Crisis).
Yet, despite these impressive figures, investors have another quality choice in the space that could also offer robust volume; the Vanguard MSCI EAFE ETF (NYSEArca:VEA - News). This fund has a comparatively small amount of assets at $6 billion and trades about 2.4 million shares a day, still respectable figures no matter how you slice it. However, it seems as though most have looked over the fact that both VEA and EFA track the MSCI EAFE Index and that VEA charges just 15 basis points a year compared to 35 basis points for EFA. This represents a cost that is more than double for pretty much the exact same exposure, suggesting that pretty much all types of investors—be they traders or long-term buy-and-holders—would be better off taking a closer look at VEA for their exposure to the region.
Broad Bond Funds
With bonds outperforming stocks in 2011, the sector looks to attract considerable interest from a wide range of investors. Luckily, there is no shortage of options in the space including three products that track the same Barclays Capital U.S. Aggregate Index; AGG, LAG, and SCHZ. Yet while all three have the same underlying benchmark, their fees are quite different.
AGG is currently the leader in the space with $14 billion in AUM and volume of 1.1 million shares a day. This is in sharp contrast to both of the other products in the space, LAG and SCHZ, which together barely combine for one-tenth of the figure on the volume side and less than 3.5% of the AUM of the iShares fund. This is especially surprising as AGG charges investors 22 basis points a year while LAG has expenses of 13 basis points and SCHZ has a cost of just 10 basis points a year (read The Best Bond ETF You Have Never Heard Of).
In other words, investors have two options in order to get exposure to the same index for half the cost in the bond space, but for whatever reason many are choosing not to do so. While the low trading volumes are undoubtedly one of the reasons, for long term investors it would seem to make more sense to have an allocation to LAG or SCHZ, despite the wider bid ask spreads, rather than paying double every year for AGG.
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Author is long VWO, IAU.