Most passive index-based exchange traded funds charge lower expense ratios that are comparable to mutual fund institutional share class fees.
On an asset-weighted basis, three of 14 ETF categories showed a lower asset-weighted expense ratio than their mutual fund counterparts, writes Alex Bryan for Morningstar.
Specifically, large-cap blend, mid-cap growth and small-cap blend categories whoed that ETFs have a lower asset-weighted expense ratio than mutual funds. However, when comparing the asset-weighted expense ratio, cheaper institutional share classes are also factored in.
“Index mutual funds’ institutional share classes pull the asset-weighted average expense ratio down,” Bryan said.
However, these institutional shares are only available through a high minimum investment or on select retirement platforms.
Consequently, on an asset-weighted basis, ETFs don’t have a cost advantage to retail mutual fund share classes when it comes to emerging market, foreign large-cap blend and small-cap value stocks. Compared to institutional shares, ETFs only have a cost advantage in the mid-cap growth category.
ETFs make significant headway when comparing tax efficiencies to mutual funds. For instance, the median active fund in the large-blend category had a median turnover of 46% in 2013, which contributed to their higher capital gains distributions. In contrast, median market-cap-weighted index funds only had 5% turnover rates, and ETFs build upon their tax advantage through so-called “in-kind” redemption and creation process, which allows managers to transfer low-cost-basis shares out of a fund in a tax-free transaction.
ETF investors, though, could see a slight disadvantage to no-load index funds since ETFs trade like stocks and come with brokerage-fees on each transaction. Nevertheless, many of the major brokerage platforms do offer a range of commission-free ETFs that trade with zero cost. [Advisors Flock to Commission-Free ETFs]
“When equity index mutual funds and ETFs track the same benchmark at comparable expense ratios, ETFs may be the better option for taxable accounts,” Bryan added.
Additionally, investors will have to factor in indirect rading costs, such as the bid-ask spread and market impact of trading the ETF. [What is an ETF? — Part 7: Bid/Ask Spread]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.