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ETFs Are Cheaper than Tracker Funds

Looking for a cheap tracker fund? You'll generally save more pennies by buying an exchange-traded fund

Holly Cook 30 September, 2013 | 1:45PM

Though traditional index funds might be a cheaper option for institutional investors, for the average Joe like you and me, exchange-traded products (funds and commodities) are a much more competitive option. New research from Morningstar’s European Passive Fund Research Team has shown that ETF fees consistently come in lower than their tracker cousins—for retail investors at least—with around some 40% of European large-cap equity index funds charging private investors a total expense ratio in excess of 1% for merely tracking an index. 

The report shows that because traditional index funds have a dual charging structure—whereby they charge one fee to private investors and another, usually significantly lower, fee to institutional investors—they tend to be a cheaper for institutional investors compared to ETFs, which have just one total expense ratio for all investors. However, ETFs' consistently low fees mean that they undercut the costs charged by trackers to retail clients and are therefore the cheaper option. 

Fees' relentless ability to eat into returns is an important consideration for all investors, so the release of this report, which outlines average fees for both traditional trackers and ETFs offering exposure to a range of asset classes, is a crucial and useful tool for both private and institutional investors. 

Among equity investments, total expense ratios for both equity index funds and equity ETFs have dropped on average over the past five years, largely as a result of new launches undercutting older, established ones. Looking at all the equity categories together, the average TER for a retail index fund is 0.73% and for an institutional index fund is 0.32%; the average 0.39% cost of an equity ETF therefore compares rather favourably. 

Conversely, fixed-income ETFs have seen an overall increase in average TER since 2008 as products become more specialised and amid a lack of real competition within the asset class. Across all fixed income categories, index funds’ retail share classes charge an average 0.35%, while their institutional counterparts cost a slightly cheaper 0.28%. ETFs beat both, however, with an average TER across the fixed income spectrum of just 0.23%. 

For investors looking for more niche investments that provide narrow exposure to specific sectors such as agriculture, energy and precious metals, ETFs are pretty much the only option available, with 255 ETFs available compared to just 36 index funds with retail share classes. The average cost of a sector ETF comes in at 0.45% versus 1.14% for sector-specific trackers. 

Compare costs by clicking the table below to enlarge.

See the full Morningstar Research Paper on ETF and tracker funds here.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author Holly Cook

Holly Cook  is Managing Editor of Morningstar.co.uk