Research carried out by Morningstar entitled “Assessing the true cost of strategic-beta ETFs”, compared fees, replication costs and trading costs for 100 European-domiciled smart beta ETFs and 77 market-cap-weighted ETFs linked to broad equity benchmarks. The report found that the average total expense ratio (TER) of a smart beta (or strategic) ETF using the S&P 500 as its parent index was three times higher than that of an ordinary S&P 500 ETF (0.43% compared to 0.14%). The average fee for an emerging markets smart beta ETF is slightly more than that of its market-cap-weighted counterpart at 0.60% versus 0.53%.
The increase in costs was also put down to the relatively higher replication costs (smart beta indices experience turnover usually ranging from 20% to 30% per year whilst average turnover rates for standard market-cap-weighted indices are between 3% and 8%).This can be explained due to the fact that smart beta ETFs are relatively new, small and used as buy-and-hold investments. Data from Morningstar shows that there were 950 smart beta exchange-traded products representing approximately $478 billion in assets worldwide, as of 31 December 2015.
Hortense Bioy, CFA, Morningstar’s Director of European Passive Funds Research, said in a note: “Investors in strategic-beta ETFs, like those investing in actively managed funds, are more concerned with performance and the intricacies of a specific strategy than they are with cost… While this is understandable, they should keep in mind that there is a wide disparity in the fees charged by strategic beta funds, even by those offering exposure to similar strategies, and that low-cost funds have greater odds of future success.”
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