The current fee battle between exchange-traded fund (ETF)
companies took an odd twist this week with the launch of 10 new
Fidelity sector ETFs.
The headline story was that
Fidelity's MSCI linked sector ETFs
are "nearly 80% below the industry average for passive sector ETFs"
and even cheaper by two basis points (0.02%) compared to their
rival Vanguard's MSCI sector ETFs.
The other story line is that Fidelity hired BlackRock as
sub-adviser for its 10 passive sector ETFs, "leveraging the firm's
passive investment management capabilities and scale."
And here's where the story's plot thickens: BlackRock also
manages its own sector ETFs under the iShares brand, which begs the
question; How does BlackRock justify charging fees on its iShares
sector funds that are almost four times more expensive versus the
0.12% fee it receives for sub-advising Fidelity MSCI sector
The 31 U.S. sector ETFs offered by BlackRock's iShares have
average expense ratios of 0.45%. The bulk of these iShares sector
ETFs (27) track Dow Jones Sector indices and charge 0.45% annually.
The others, like the iShares Nasdaq Biotechnology ETF
(NASDAQGIDS:IBB), iShares Real Estate 50 (NYSEARCA:FTY), and
iShares PHLX SOX Semiconductor ETF (NASDAQGIDS:SOXX) are linked to
non-Dow Jones indices and charge slightly higher expenses of 0.48%.
Among the group, the iShares Cohen & Steers REIT ETF
(NYSEARCA:ICF) charges the lowest expense ratio of just 0.35%.
Occasionally, there can be significant discrepancies between the
cost of ETFs in the same investment categories, as the iShares U.S.
sector ETFs illustrate. But for the most part, the fees charged by
ETF providers are still tame compared to the infinitively bad
For instance, compared to the mutual fund and hedge fund
industry's bloated fee structures, the expense ratios in the ETF
industry are a bargain. The average expense ratio for international
stock mutual funds (
) is 1.57% whereas it's just 0.56% with international stock ETFs,
according to FINRA's fund analyzer tool. That's a 64% cost
difference and enormous potential savings for investors that choose
Still, the prudent investor - even with ETFs - should take
deliberate steps to make sure they aren't paying more than
In certain cases, it might make sense to pay a slightly higher
fee (but one that's still in the same general ballpark as its
peers) for market exposure that isn't available elsewhere.
For instance, the
Select Sector SPDRs
follow each of the nine industry sectors within the S&P 500
(NYSEARCA:VOO) and charge a modest annual expense ratio of 0.18%.
If you want exposure to specific S&P 500 stocks within a
certain sector, say energy (NYSEARCA:XLE) or technology
(NYSEARCA:XLK), the Sector SPDRs are your only choice, and a pretty
good one at that.
Getting back to the original question: Why do iShares sector
ETFs cost so much? There could be a myriad of reasons.
Maybe it's becauseBlackRock is stuck in a bad contract with SPDR
Dow Jones Indices that forces them to pay substantially higher
sector index licensing fees and they're merely passing on those
higher costs to investors. Or, maybe it's because aggressive fee
cuts aren't a corporate priority.
Whatever the reason, there's a valuable lesson for all of us.
Buying ETFs with fees that are meaningfully higher versus their
peer group, whether they are sector funds, bond funds, or something
else, is usually a bad deal.
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