But two comments on that number:
1. On an asset weighted number basis the average fee is far lower. Most of the assets in etfs are in broad asset classes from the leading providers and carry far lower fees, For example the vanguard small cap etf has a fee of .10% and the ishares s+p 500 etf has a fee of .09%.
2. In some but not all cases the higher priced etfs are in asset classes where the active funds carry higher fees. Thus the ishares emerging market etf carries a fee of .74%, the vanguard etf .25% but the average of the actively managed mutual funds for the category of emerging markets is 1.72% (for domestic funds it is 1.33%). So in some cases the higher fees for the etf is paralleled by higher fees in the same category in the active fund category.
The article goes on to argue that the trading costs for some etfs are prohibitively high:
"Lower ETF assets generally mean higher trading costs for investors.
Consider the "bid-ask spread," or the gap between the price buyers are willing to pay and the price sellers are asking. Only about a dozen ETFs have more than $10 billion in assets. All have small spreads, amounting to less than 0.09% of the price that is midway between the bid and ask price, according to New York Stock Exchange data for the first seven months of this year.
By contrast, nearly 200 ETFs have spreads over the 0.5% mark. A spread that wide is "not acceptable," said IndexUniverse's Mr. Hougan. It means an investor who buys and sells the fund could lose more than 1% of his investment to the spread, which is more than most ETFs' expense ratios".
While it may be true that the bid ask spreads for etfs reflect trading costs, in most cases the bid/ask that appears on quote screens does not reflect actual transaction costs.
Making an assessment of trading costs based simply on the bid/ask spread that appears on a quote screen is incredibly simplistic for several reasons.
Firstly no one should ever put in market orders for any but the most liquid etfs. Simply putting in a limit offer in the middle of the bid ask spread will get the trade executed in most cases. I do this for all the etf trades I make for my client portfolios.
Why is this the case:
The posted bid ask spread for the etfs is really just an indication of where the market makers are willing to trade at minimum risk. It is important to remember that etfs are a form of derivative product. That means the price of the etf is derived from the price of the basket of underlying securities that make up the etf. The market makers in the etf have at their fingertips the value of the etf based on the stock prices and they will hedge their position with trades on those stocks. The posted bid ask is a wide spread around that value because initially there may be little price competition among market makers and the market maker posting the price is happy to collect the easy money from those unsophisticated enough to put in market orders (this phenomenon is common in many thinly traded derivative markets such as deep out of the money options on stocks or futures. But the market makers in most cases will be willing to trade inside that spread.
In fact the value of the underlying stocks--the intrinsic value is not some kind of deep secret held only buy a few wall street bigshots. It is readily available the symbol would be the ticker for the etf followed by .iv for instance EEM.IV for the ishares emerging market etf A good guideline for an order is to try to put in a limit order close to the intrinsic value. If one is trading close to intrinsic value the bid ask spread is pretty much irrelevant as a measure of your trading costs.
So if the real active market for the etf is "inside" of the bid/ask spread that initially appears on the computer screen, it only goes to reason it is a pretty poor measure of trading costs. It's akin to calculating car dealers' markups on autos based on the first price offered when you walk onto the dealer's lot, or measuring housing prices in the current market based on the offering price first quoted. Those numbers are irrelevant what matters is the price where the trade gets made.
In the case of foreign stock etfs a wider bid ask spread (although probably not .50%) is in my view justified given the risks undertaken by the etf market maker. Think about his situation: he is quoting a price on a basket of stocks for markets that are not open (certainly not during the entire US trading day)with price risk on the stock and on the currency movements. Yet as someone purchasing or selling the etf I get full transparency on my trade.
Consider the alternative of an actively traded mutual fund,for example in emerging markets. The purchaser or seller of the emerging market fund must buy or sell the fund at only one time: at the end of the US trading day. Yet the NAV of that fund is set based on the prices at the market close in the local markets. Talk about buying a blind item ! I would certainly prefer the opportunity to trade the etf throughout the day.
Furthermore, just because one buys an actively managed mutual fund the transaction costs don't disappear, they are just buried. A study by Vanguard (available on their financial advisor website) estimates transaction costs on emerging market trades at 1% in each direction (2% round trip) twice that of developed markets.
So there is probably less than meets the eye looking at that computer screen with the bid/ask spreads on etfs. That spread is not a true representation of the trading costs of etfs, certainly not for someone who takes even the most minimal step for reducing costs by using limit orders.
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