Yep … that’s the point.
Even though a fund sponsor’s operating costs for managing an ETF may, indeed, be lower than those for managing a similar traditional mutual fund, that doesn’t necessarily translate into lower costs for ETF investors. As my high school English teacher liked to scrawl in red ink across my paper, “can” (as in “can” charge less) and “will” have very different meanings.
Most ETF sponsors need to generate a profit for their own investors. As a result, the expense ratios they charge will include both the cost of managing the fund and a profit margin for the management company’s owners.
In Vanguard’s case, the management company is owned by its funds. After operating costs, all other profits are returned to the funds’ shareholders through lower costs. The result: Vanguard’s ETF dollar-weighted expense ratio is 0.12% as of February 28, 2013, compared with the 0.30% industry average shown above.
Even though many may argue the ETF structure leads to lower costs than mutual funds, it’s really the structure of the investment and the ETF provider’s pricing strategy that determine the costs that investors may pay. The debate of ETFs versus mutual funds is quite often simply a debate about the costs of indexing versus active. When looked at on a more apples-to-apples basis, ETFs and mutual funds can both provide access to low-cost index strategies. Further cost differences can be potentially explained by higher expense ratios used to pay additional profits to investors in the management company.
Joel M. Dickson, Ph.D., is a senior investment strategist and a principal in Vanguard Investment Strategy Group, where he analyzes trends and developments in the ETF market and provides research and commentary on issues related to ETFs.