The top reason to invest in exchange-traded funds as opposed to other choices is the low cost of ownership – end of debate.
But the ETF industry has in the past year had some success selling high-cost funds. A report from National Bank Financial shows that close to 12 per cent of money flowing into ETFs in 2021 went to products with management expense ratios of 1 per cent and more. For context, you can buy exposure to the S&P/TSX Composite or S&P 500 indexes with MERs of 0.06 to 0.1 per cent.
NBF’s report shows that high-cost funds still represent just a small fraction of total ETF assets – less than 5 per cent. But the popularity of high cost ETFs is worth noting because it recalls past experience in the mutual fund industry with similar products.
These trendy mutual funds tended to be expensive, one reason being that you can get cute on pricing when there’s strong demand. But when the trend faded, it was common for these funds to fall hard in price. In the example of science and technology funds in the early 2000s, many withered to a point where they were merged into other products or closed.
ETF companies are now the prime movers in popping out new funds to exploit trends. NBF attributes the popularity of high-cost funds last year to “the buying frenzy in newly launched crypto-asset ETFs and the adoption of alternative ETFs (market neutral, hedge fund type strategy, etc.).”
Paying a high MER for an ETF only makes sense if it out-earns the mega-cheap, index-tracking funds that continue to hold the most ETF assets. In the short term, this outperformance is certainly possible. But over the long term, it’s doubtful. In fact, some high flying stocks and ETFs have recently started to drop considerably in price.
If you own a high-cost, trend-following ETF, now’s the time to evaluate whether your returns justify the cost. There’s nothing wrong with cutting a fund loose if it no longer makes sense, even if you’re down in price. Selling some or all of a speculative ETF to lock in profits is also worth a thought.
The NBF report shows that more than 50 per cent of all ETF assets and inflows last year were into funds with MERs between zero and 0.3 per cent, which is admirably cheap. NBF figures that investors are using a barbell approach of putting a large segment of their portfolio into low-cost index tracking ETFs and the rest to more expensive, higher risk products.
Low fees are an excellent foundation for an ETF you keep for the long-term. Funds with a high fee need to be handled much more carefully.
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