There's been quite a bit of hullaballoo lately over whether
iShares raised the expense ratios on 40 of its funds.
Recently filed prospectuses, which became effective on Jan. 1
but covered fund economics for the 12 months ended Aug. 31, 2012,
indicate that the expense ratios on 40 funds rose.
But officials at iShares say the expense ratios listed in those
prospectuses are backward-looking and no longer accurate, and that
it's not raising any fees. In fact, thanks to asset growth at
iShares, the fees that investors experience in 2013 may be
than either the latest prospectuses or the iShares website
Confused? That's OK, because any changes to these expense ratios
don't really matter.
Whether the fee on a fund like the iShares MSCI Emerging Markets
ETF (NYSEArca:EEM) is 0.67 percent-as iShares' website says-or a
few basis points more, as the latest prospectus indicates,
shouldn't change the analysis that leads an investor to invest in
the fund in the first place.
After all, an investor already now has access to
cheaper emerging markets exposure in the similar iShares Core MSCI
Emerging Markets ETF (NYSEArca:IEMG), which has a 0.18 percent
If you've already chosen EEM over IEMG, do you really care
whether the expense ratio difference is 0.49 percent or 0.51
But that's not even my main point.
The real reason it doesn't matter is that the expense ratio is
only part of the equation when it comes to determining the true
cost of your exposure to an index. The expense ratio matters to the
issuer, since it determines how much it gets paid, but it shouldn't
necessarily matter to the investor.
After all, when you buy an index-based ETF, the important thing
is how closely the ETF tracks its underlying index.
Generally, the expense ratio is the best predictor of that
tracking difference, since you'd expect a perfectly tracking ETF to
deliver the returns of its index minus its expense ratio. But
that's not always the case.
First of all-and this one is obvious-not all
track their indexes perfectly. Even if they fully replicate their
underlying indexes, ETFs have to contend with things like trading
costs that their indexes don't. Many ETFs earn additional revenue
by lending out their securities, which can pad returns, and many
also optimize their portfolios, which can lead to either positive
or negative tracking error.
Thus, the important thing to look at isn't expense ratios, but
rather how much the ETF has actually tended to lag its underlying
If an ETF costs 0.20 percent a year but does a terrible job with
tracking its underlying index and tends to lag it by 0.50 percent,
it's not any more attractive to me as an investor than a fund that
both charges 0.50 percent and lags its index by 0.50 percent.
One way to look at the tracking difference-and the one we use in
ETF Analytics-is to look at the rolling 12-month differences
between an ETF's return and its underlying index's return.
In other words, you calculate the difference between the ETF's
returns and the index's returns over the 12-month period ending
today, and then work your way back using rolling 12-month periods
ending yesterday, the day before, etc., until you have a reasonably
sized data set.
Our ETF Analytics data set, for reference, covers two years of
data, or about 255 12-month return tracking differences.
So let's look at some of the biggest iShares funds that we
originally reported had raised their expense ratios. By assets, the
five biggest are:
- iShares MSCI Emerging Markets ETF (NYSEArca:EEM), with $48.2
- iShares MSCI Brazil ETF (NYSEArca:EWZ), with $9.3
- iShares MSCI Japan ETF (NYSEArca:EWJ), with $5.2 billion
- iShares MSCI Canada ETF (NYSEArca:EWC), with $4.7
- iShares MSCI Germany ETF (NYSEArca:EWG), with $4.0
It turns out that the median tracking differences on all five
funds are significantly lower than the expense ratios-on average,
iShares is doing better than you'd expect by looking at the expense
EWG, to take the most extreme example, charges 0.51 percent in
fees, but only lags its index on average by 0.04 percent, making it
Given that, the concern over whether the expense ratio is 1-2
basis points higher than it was previously is virtually moot.
Don't forget to check IndexUniverse.com's ETF Data
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