Are Free ETF Portfolio Strategies Really Free?

By Henry Ma, Julex Capital

One of the recent developments in the ETF strategist industry that caught advisors’ attention is so-called free ETF portfolios.

Fierce Competition and More Fee Conscious Investors

Facing fierce competition and more fee conscious investors, many ETF issuers created ETF portfolio strategies with their own proprietary ETFs and offered them for free. On the surface, it sounds like a good thing for investors because they help lower the investment expenses. However, if you look more closely under the cover, it is not clear-cut whether there is a cost-saving for using free ETF portfolios.

Table 1 compares the fees of three different ETF Portfolios. Portfolio A is a typical portfolio created by ETF strategists.  Normally ETF strategists use the most liquid and least expensive passive ETFs to create ETF portfolios, most of which are dynamic and tactical in nature. Depending on how active the portfolios are managed, the fees of ETF portfolios vary.  In this example, we assume that the ETF strategist charges 30 bps for a total portfolio solution, then the total fee including the expenses of the underlying ETFs (assuming 15 bps) is 45 bps.

Portfolio B is an example free ETF portfolio created by ETF issuers. Depending on the breadth of the ETFs they issue, ETF issuers normally use a combination of the passive ETFs and their proprietary active ETFs. Just like active mutual funds, active ETFs have high expense ratios.  In Portfolio B, we assume that the active proprietary ETF charges 100 bps, then the total fee is 58 bps, which is much higher than that of Portfolio A even there is no extra strategist fee.

Portfolio C is another type of free ETF portfolio. The largest ETF issuers often offer ETF portfolio strategies with their own passive ETFs at no extra charge. In this example, the total fee of the portfolio is 15 bps, the lowest among three portfolios. However, this type of portfolio typically follows a passive strategic asset allocation approach without any active management. Advisors can implement a core/satellite approach to manage client accounts by using this portfolio as a core holding and other active/tactical ETF portfolios as satellites to enhance returns or/and reduce risk.

Additionally, the proprietary ETFs used in the free Portfolio B and C may not be the best in their asset class or investment style categories. In many cases, there are substitutes managed by other firms that may have better performance record, lower expense ratios or more liquidity.