A top Vanguard [profile] executive is trying to debunk the widespread perception that ETFs are cheaper than mutual funds.

Drawing from an ETF roundtable discussion published in this week's issue of Barron's, "Focus on Funds" columnist Brendan Conway highlights data presented by Vanguard strategist Joel Dickson, which eschews the traditional and misleading "compare fees for all ETFs, most of which are passive, to fees for all non-ETF mutual funds, most of which are active" logic by comparing passive ETF fees with those of index mutual funds.

Dickson finds that index mutual funds cost an average annual expense ratio of 15 basis points, half the 30-bps average of index ETFs. And active ETFs cost 93 bps on average, higher than the 82 bps average for active mutual funds.

Conway notes that part of the discrepancy, noticeable in almost every broad asset class, is explained by the prevalence of niche, strategy indexes in the ETF world; more complicated and less popular means more expensive.

Conway makes no mention of two other pricing discrepancy driver that help make ETFs look cheaper than traditional mutual funds. Mutual fund expense ratios include distribution costs, i.e. sub-TA fees and 12b-1s, and investors do not pay a brokerage trading fee to buy or sell shares. ETF investors, on the other hand, must pay brokerage account and trading fees on top of whatever they pay for the ETF itself. And unlike regular mutual funds, which can be bought and sold directly at NAV every day, ETFs have bid-ask spreads, gaps between what you can buy shares for and what you can sell them for. Those spreads, which tend to be bigger with more niche, lower trading volume ETFs, erode investors' returns by preventing them from buying and selling at NAV.  

Edited by: Neil Anderson, Managing Editor


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