More and more investors are using passive funds such as exchange-traded funds (ETFs) and index tracking funds to reduce the overall cost of investing. In a world of low expected returns across all asset classes, investors should be scrutinising their investment costs more closely than ever. Investors who haven't checked for several years to see if their passive funds are competitive may be in for a shock.
Over the past five years there has been a trend towards reduced fees in the traditional index-tracking industry. This trend has been most prominent in the industry since 2009, and was spurred by Vanguard's entry into the market. The US firm rolled out a suite of ultra-cheap trackers, which immediately prompted HSBC to slash fees on several of its UK index funds. More recently, in April 2013, Legal & General cut fees on a number of its index tracking products.
Meanwhile, a September 2013 report from Morningstar found that total expense ratios for European-domiciled equity ETFs have dropped since 2008. The total expense ratio - and its new reincarnation the ongoing charge - represents the portion of an investment that will be extracted by the fund on an annual basis and covers costs incurred by the fund in direct relation to the management and administration of the fund.
Morningstar reports that the decline in TERs has come primarily as a result of new products undercutting older ones, rather than the latter cutting fees. However, the new and cheaper products have often been slow at garnering assets.
A case in point is the S&P 500 ETFs launched by HSBC, db X-trackers, Amundi, Credit Suisse and Vanguard since 2010. With TERs ranging from 0.09 per cent to 0.20 per cent, according to Morningstar they each attracted between €470m (£394m) and €590m of net new assets by the end of 2012. However, the longer-running iShares S&P 500 ETF (IACC), which levies a significantly higher TER of 0.40 per cent gained €2.2 billion over the same period.
However, investors considering whether to use an ETF or an index tracker fund may find ETFs a better place to start their research in light of cheaper average fees in that sector.
The Morningstar report found that across all equity and fixed income exposures, exchange-traded products are on average cheaper than index funds when measured against the latter's retail pricing structure. Weighted by assets, the average total expense ratio (TER) for equity ETFs is 0.39 per cent, compared with 0.73 per cent for retail equity index funds.
Nevertheless, while charges are an important thing to consider, investors also need to check that they understand the composition of the index that they are tracking. And they also need to check the tracking difference between the performance of that index and the product that they are using to track the performance. There is no point using a cheap product if it fails to track the index closely.
To help with your research below are the average costs of equity tracker funds and ETFs, as identified by Morningstar. However, note that average costs can disguise a vast range of costs, as shown by the second table below of funds and ETFs that track the FTSE All-Share index.
Average Total Expense Ratios for equity tracker funds and ETFs
| Equity category | Index funds retail Average TER % | ETFs Average TER % |
| Global | 0.66 | 0.47 |
| Europe Large Cap | 0.73 | 0.26 |
| Europe Mid-Small Cap | 0.35 | 0.44 |
| US Large Cap | 0.64 | 0.35 |
| US Mid-Small Cap | N/A | 0.41 |
| Emerging Markets | 0.91 | 0.68 |
| Developed Asia-Pacific | 0.6 | 0.56 |
Source: Morningstar. Asset-weighted average calculations of TER at March 2013. N/A where the fund sample qas too small to be considered representative.
COST OF USING FTSE ALL-SHARE TRACKERS
| Tracker fund or ETF | Ongoing charge |
| Scottish Mutual UK All Share Idx | 0.09 |
| Royal London UK All Share Tracker Z Acc | 0.14 |
| Vanguard FTSE UK Equity Index Acc | 0.15 |
| Vanguard FTSE UK All Share Index UT Acc | 0.15 |
| L&G UK Index I Acc | 0.17 |
| BlackRock UK Equity Tracker L Acc | 0.21 |
| HSBC FTSE All Share Index R Acc | 0.27 |
| Fidelity MoneyBuilder UK Index | 0.30 |
| Scottish Widows UK All Share Track I Acc | 0.35 |
| db x-trackers FTSE All-Share | 0.40 |
| Lyxor ETF FTSE All Share A/I | 0.40 |
| M&G Index Tracker A Inc | 0.46 |
| F&C FTSE All-Share Tracker 1 Inc | 0.47 |
| Old Mutual UK Index A GBP Acc | 0.49 |
| Henderson UK Index A Acc | 0.76 |
| Allianz UK Index A Acc | 0.79 |
| Virgin UK Idx Tracking Trust | 0.91 |
| Threadneedle Nav UK Index Tracker | 0.92 |
| Aviva Investors UK Idx Tracking 1 Inc | 0.93 |
| Halifax UK FTSE AllSh Idx Track C | 1.00 |
| Henderson Instl UK Equity Tracker Trust | 1.03 |
| SWIP Foundation Growth A Acc | 1.12 |
| L&G (N) Tracker Trust Acc | 1.15 |
Source: Morningstar
