ETF cost war: Investors left in dark?

Oct 04 2012, 13:37 IST
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SummaryExchange-traded funds are waging a price war that may save investors money on fees.

Exchange-traded funds are waging a price war that may save investors money on fees, but cheaper fund choices pose a greater risk because they may rely on new, more-opaque indexes.

Vanguard fired the latest volley in the cost-cutting campaign on Tuesday when it said it was switching 22 index funds away from benchmarks provided by MSCI Inc., a leading index developer..

U.S. ETFs - baskets of securities like mutual funds that trade on exchanges like individual securities - hold more than $1.2 trillion in assets and are an important revenue generator fo r asset managers.

ETFs appeal to cost-conscious investors because they are cheaper than mutual funds. They also allow investors to trade throughout the day, with simultaneous pricing, unlike mutual funds, which price at the end of the day. ETFs are largely passively managed, tracking indexes rather than being actively run by a portfolio manager.

Vanguard, long the low-cost leader, has been gaining market share over the last several years. But rivals such as BlackRock Inc and Charles Schwab Corp. have grown more competitive. BlackRock has announced plans to lower fees, while Schwab last month slashed its ETF fees - sometimes to pennies.

Instead of the MSCI indexes, Vanguard now will use less-pricey FTSE Group indexes for six international stock funds.

Vanguard will also use indexes designed by Chicago's Center for Research in Security Prices for 15 stock and balanced funds and ETFs. The center, known as CRSP, has been working with institutions for decades but is unknown to individual investors, unlike well-known rivals such as Standard & Poor's or Russell Investments.

Unlike the MSCI, which uses a transparent rules-based methodology, CRSP's modeling is more opaque and nuanced, experts said.

These are brand-new indexes that are not battle-tested and they have some non- transparent rules in how they get constructed, said Dave Nadig, director of research at IndexUniverse, which tracks the ETF industry.

CRSP's Chief Operating Officer David Barclay said the different methodologies should not be a drag on a fund's returns. And Joel Dickson, senior ETF strategist at Vanguard, said CRSP's approach is not a big departure from that of MSCI.

We are talking about angels on the end of a pin and not broad-based differences, Dickson said.

Vanguard discloses fund holdings quarterly, not daily as its competitors do. That makes it harder for investors to know what securities they own, but it prevents traders from knowing Vanguard's moves

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