Why Smart Beta Costs More

Market Realist: Is there anything else that you would like to add?

Dave: I often see in the press that “smart beta costs more.” It’s important to understand that it’s really what we’re comparing smart beta against. These are not higher fees against active mutual funds or hedge funds. I was actually, for another purpose, looking up a mutual fund today that basically tracks a traditional smart beta strategy. It had a 5.7% front load and a 1.7% annual management fee. If you think about it, not necessarily delivering anything advanced from a return perspective, and an investor in year one is paying more than 7% to get to that return. So, a smart beta ETF that would charge 65 bps or 40 bps – and there are some that are even less – that’s basically free when you compare it with the active side.

Market Realist’s View:
The Declining Cost of Investing

The expense ratio is the annual fee charged by funds to their investors for expenses related to fund management, including management fees, administrative fees, and operating costs. Normally, the expense ratio is very high for funds with small asset bases because the fund has to meet its expenses from a limited resource base. In contrast, expense ratios go down with a rise in asset base as expenses are divided across the larger asset base.

Why Smart Beta Costs More

The expense ratio is expressed as a percentage of assets under management. As the chart above shows, expense ratios vary with the type of fund. According to Morningstar Investment Research, the asset-weighted expense ratio across all funds, including mutual funds and exchange-traded products, fell to 0.64% in 2014 from 0.65% in 2013 and 0.76% in 2009.

Presently, the average ETF carries an expense ratio of 0.44% or $44 per year for every $10,000 investment while the average traditional index fund costs 0.74%.

Hedge funds may charge higher management fees of around 1-2% regardless of the fund’s performance. However, in recent times, average hedge fund fees have fallen to 1.67% of total assets under management.