DIY Investor Magazine
/
December 2015
43
The total cost of owning an ETF isn’t completely
captured by the TER or its near identical twin, the
Ongoing Charge Figure (OCF).
These are the charges that you will see quoted on a
product’s website or in the Key Investor Information
Document (KIID) and are deducted pro rata from your
holdings on a daily basis; but it isn’t the full price you’ll
pay – for that we need to consider the Total Cost of
Ownership.
The TCO isn’t generally found on a website or factsheet
because, whilst the TER and OCF have been agreed
between the investment industry and the European
Union, there is no standard definition of the TCO.
Nevertheless, investors should consider the TCO when
selecting ETFs because the product with the cheapest
TER isn’t necessarily the cheapest product you can
buy.
The TER and OCF include the ETF’s annual
management charge plus various other expenses
including index licensing fees, legal fees,
administration, marketing, regulation and auditing.
The TCO captures extra internal costs that are missed
by the TER including dealing fees, spreads and taxes
or swap fees in case of synthetic replication that are
incurred on the ETF’s underlying holdings; gains from
security lending are also attributed to it.
One of the great advantages of
ETFs is that they are a cheap way
to invest; cost is a crucial factor
in determining your long-term
success, so consider the Total
Cost of Ownership (TCO) as well
as the Total Expense Ratio (TER).
On top of that come external costs that are more visible
to the investor which include platform charges, dealing
fees and the bid-offer spread you pay when you trade
the ETF. Total Cost of Ownership for an ETF investment
TOTAL COST OF OWNERSHIP FOR AN ETF
INVESTMENT
COST OF ETFS
Tracking difference is the discrepancy between an
ETF’s returns and the returns of the index it aims to
replicate and it helps to uncover any hidden internal
costs.
For example, if an index returns 10% and the ETF
returns 9% then the tracking difference is 1%; the
difference is effectively the TCO plus the costs
discussed above.
Tracking difference can actually be positive if an ETF
earns extra revenue from activities such as securities
lending or benefits from a more favourable tax regime
than is included in the calculation of the index return.
It may even be because the ETF’s composition
differs slightly from the index and this plays out to its
advantage.
If you compare the returns of several ETFs replicating
the same index, usually the one with the highest returns
- within several time periods - shows the lowest TCO.
ETFS AT A GLANCE
