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ETFs: Why quality matters
on Aug 12, 2013
Although exchange traded funds (ETFs) have been available in the UK for more than a decade, many advisers are still unfamiliar with them.
And as with any newer product, especially in the financial world, various misconceptions about ETFs have persisted over the years.
But with the Retail Distribution Review (RDR) driving industry change - and a growing focus on value for money – demand for low-cost index products is increasing, and inflows into ETFs are expected to rise.
Over the coming weeks, we’ll look at ten of the most common ETFs myths, hoping to increase understanding of a product designed to offer a simple, cheap and transparent way into markets.
Myth 4 – You should just buy the ETF with the cheapest TER
The total expense ratio (TER) should be a key consideration when selecting an ETF, however keep in mind this is just one element of the fund’s total costs.
Other implicit costs (such as trading costs and portfolio rebalancing) and tracking difference (difference between the fund’s gross performance and the underlying index’s performance) also impact the ETF’s overall performance.
The total cost of ownership (TCO) is a holistic view of costs, which extends well beyond the TER and includes the impact of potential revenue generative capabilities such as securities lending or intelligent index event management. In some cases this revenue virtually cancels out the TER, in others the TCO may actually be higher than the TER.
The “look beyond the TER” rule also applies when comparing the cost of an ETF with a traditional tracker. At first glance, ETFs might appear more expensive, but again TCO provides a clearer comparative picture.
In any case, the choice of one or the other should largely depend on the investment horizon and requirements of the client.
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More from us
- Read the first ETF first myth, 'Time to shatter the ETF myths'
- You can also read about how ETFs have thrown off their 'unexciting' image.
- As well as 'Not all ETFs were created equal'