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How low-cost are Core ETFs?

Exchange-traded fund (ETF) providers are pushing ranges of new 'core' ETFs, billed as cheaper versions of the most popular funds. But are these ETFs really better than their originals?
April 28, 2015

The launch of new 'core' ETF ranges from iShares and Deutsche Asset & Wealth Management in 2014 introduced rock-bottom charges and investors scurried to sign up. But the cheaper total expense ratios (TERs) on these new products, designed to be the core foundations of a portfolio, did not necessarily mean lower costs for investors.

When the Investors Chronicle analysed the new ranges last year, it emerged that, in several cases, the cost of trading these new 'cheaper' ETFs actually made them more expensive than their original counterparts when they were held over shorter time periods. This was due to high bid-offer spreads - the difference between the buy and sell prices of the funds. A wide bid-offer spread means you are unable to make as much as you paid for something when you sell it on, and can hit returns hard.

iShares has been aggressively reducing the trading cost of its core range, bringing down the total cost of holding the ETF for investors on every front. The group has managed to wrestle average bid-offer spreads on parts of its core range down from 11.33 per cent in August 2013 to 4.16 per cent in March 2015.

Peter Sleep, senior portfolio manager at Seven Investment Management, says: "iShares does an excellent job at keeping the bid-offer spreads low for big products and the core products are now very big. They have a large team of people who monitor these spreads and there are a great number of market makers and authorised participants competing for business on large ETFs, which ensures that the spreads are narrow."

Liquidity is a key factor when it comes to bid-offer spread and, in many cases, it appears that a boost in popularity has brought down the cost of trading core ETFs.

 

Which core products are best and why?

The top core fund is the iShares Core FTSE 100 UCITS ETF (Dist) (ISF), according to Adam Laird, passive investment manager at Hargreaves Lansdown. The flagship fund was the first ETF to list on the London Stock Exchange in April 2000 and in March 2015 the provider slashed its ongoing charge to 0.07 per cent from 0.40 per cent, naming it as its core FTSE 100 product in the place of accumulating share class iShares FTSE 100 UCITS ETF (Acc) (CUKX).

ISF now boasts a five-day average bid-offer spread of just 0.03 per cent, the lowest of any iShares core product and the lowest of all FTSE 100 ETFs on the London Stock Exchange. It also offers the lowest TER. The price of CUKX is also 0.07 per cent, but the average five-day bid-offer spread currently stands at 0.47 per cent.

When the CUKX ETF was iShares' core product, you would have had to hold it for one year and one-and-a-half months to make it cheaper than holding ISF, which then had a higher ongoing charge of 0.4 per cent but a lower spread.

But now there is no contest. "Having a lot of assets and being regularly traded allows it to keep spread low and lowering annual charge has made it good for the long-term investor. So this really is the best all-round product now for the FTSE 100," says Mr Laird.

 

Break-even point

In order to compare the costs of a core ETF with an original ETF tracking the same index you can look at the break-even point. This is the moment at which the costs of two ETFs become equal. It is a useful calculation to compare two ETFS where one has a higher ongoing charge than another but a wider bid-offer spread.

If you intend to hold longer than the break-even point, the ETF with the wider spread and lower annual cost should be cheaper. If you hold for less time, you're better off suffering the higher annual charge for the lower spread. However, bear in mind that spreads aren't fixed, they change throughout the day and aren't predictable, so break-even points are a guideline, not a firm rule.

The break-even point for core product iShares Core S&P 500 UCITS ETF (CSP1) over the iShares S&P 500 UCITS ETF (Dist) (IUSA) has reduced from six-and-a-half months to just over four months since November 2014.

However, you would have to hold new, core ETF db X-Trackers MSCI World Index UCITS ETF (DR) 1C (XWLD) for more than a year in order to make it cheaper than the older db X-Trackers MSCI World Index ETF (XMWO).

 

When is it worth paying more for core?

It is important to remember that the word 'core' doesn't necessarily mean better. The term is used by iShares and Deutsche AM to indicate the funds they believe are good low-cost, central holdings for a portfolio and, in several cases, ETFs have been renamed to include the word but not altered.

There are also some cases where core products might not be cheaper, but might be more appealing due to changes to their composition. One of those is the iShares Core MSCI Emerging Markets IMI UCITS ETF (EMIM), which tracks a different index to its older iShares MSCI Emerging Markets (Acc) (SEMA) and iShares MSCI Emerging Markets UCITs ETF (Dist) (IEEM).

Of the three options, EMIM has the lowest ongoing charge but IEEM beats it on spread. Across all three products the break-even point is around five-and-a-half months. If holding for longer than that period, EMIM is best. SEMA is more expensive over all time periods and, if investing for less than five months, IEEM is your best option. But Mr Laird says the make-up of the core product makes it more appealing than both its peers.

Mr Laird says: "The letters IMI stand for investable markets index, which is MSCI's terminology for tracking as many stocks as they can within emerging markets. Most of the other EM products leave out small-cap investments.

"So this is a good case where the fund has got a lower TER and the product has a broader scope. EMIM invests in a wider range of companies, which gives an extra layer of diversification."

Alan Miller, founder of SCM Private, says: "Many of the iShares core products are excellent, not just because of their low charges but because they tend to cover a larger amount of the relevant markets."

"The iShares Core Emerging index has a spread of 0.41 per cent, which is higher than their other MSCI Emerging Markets ETF but probably reflects the slightly higher costs attached to buying some of the smaller/medium-sized stocks in the portfolio."

 

Passive ratings systems and trading costs

Weighing up the cost of passive funds against each other has always been tricky due to a variety of impacts on returns, including TER, bid-offer spread and tracking efficiency. Last week, FE TrustNet launched a new passive ratings system that aims to capture a host of costs when determining the best ETFs.

The company evaluated 229 retail-focused funds, handing 'passive crowns' on a scale of 1-5 on the basis of their tracking difference, tracking error and fund size. The number of crowns a fund receives is determined by an absolute score across the three components, with tracking difference ranking highest in terms of importance and fund size having the lowest impact. The group claims to be moving away from a sole focus on costs, but argues that liquidity, and associated bid-offer spread issues, are included in its consideration of fund size.

But Mr Miller criticises TrustNet for looking at ETF size as a measure of liquidity, citing other issues as equally important. In contrast to TrustNet's approach, Lyxor compiles tracking difference, liquidity spread and tracking error into a single efficiency score to rank ETFs.

But, according to both companies, iShares emerges as highly efficient, ranking top among its Lyxor, UBS and Deutsche Bank counterparts on ETFs tracking the MSCI Emerging Markets, MSCI World and EURO STOXX 50 indices.

According to FE TrustNet, iShares topped its rankings from an absolute group perspective. Of its 34 passive funds available for being rated, 13 scooped 5 passive crowns.

 

Break-even points on sample core and non-core ETFs

FundCodeOngoing charge (%)Average 5 day spread (%)*

Break even point*

iShares S&P 500 UCITS ETF (Inc) IUSA0.400.04

4 months

iShares Core S&P 500 UCITS ETF CSP10.070.15
db X-Trackers MSCI World Index UCITS ETF DR (core product)XWLD0.190.43

1 yr 3 months

 db X-Trackers MSCI World Index ETFXMWO0.450.10

*Point at which the costs of the two ETFs are equal. If held after this point, the core ETF with the lower ongoing charge becomes the cheaper product.

Source: Hargreaves Lansdown, as at 22 April 2015

 

iShares bid-offer spread averages 2013-15 in basis points for sample core fund - iShares Euro Aggregate Bond UCITS ETF (IEAG)

Average bid-offer spread
Aug-1311.33
Sep-1310.76
Oct-138.11
Nov-137.83
Dec-1310.26
Jan-149.84
Feb-1412.18
Mar-1411.02
Apr-1411.1
May-148.22
Jun-149.41
Jul-149.77
Aug-149.1
Sep-144.95
Oct-144.45
Nov-144.58
Dec-147.59
Jan-155.07
Feb-154.18
Mar-154.16

Source: iShares

 

iShares Core ETF range

iShares Core rangeTickerAverage 5 day bid-offer spread (%)Ongoing charge (%)GBP Assets (£m)
iShares Core MSCI World UCITS ETFSWDA0.100.2£2,471
iShares Core UK Gilts UCITS ETFIGLT0.110.2£1,158
iShares Core £ Corporate Bond UCITS ETFSLXX0.140.2£1,472
iShares Core S&P 500 UCITS ETFCSP10.150.07£7,710
iShares Core EURO STOXX 50 UCITS ETFCS510.190.1£664
iShares Core MSCI Japan IMI UCITS ETFIJPA0.210.2£776
iShares Core MSCI Pacific ex Japan UCITS ETFCPJ10.270.2£89
iShares Core MSCI Emerging Markets IMI UCITS ETFEIMI0.410.25£801
iShares Core FTSE 100 UCITS ETF Income ISF0.030.07£3,802

Source: Hargreaves Lansdown, Bloomberg, Morningstar as at 22 April 2015